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Protecting Your Loved Ones from Costly Estate Taxes through an Irrevocable Life Insurance Trust (ILIT)

Aug 1, 2018 4:21:36 PM

Buying a life insurance policy undoubtedly provides your beneficiaries with financial security when your life ends, but did you know you could also unknowingly leave them with exorbitant estate taxes?

While death benefits from life insurance policies are not subject to income tax, they can still be accounted for as part of your taxable estate. To ensure your beneficiaries receive the largest inheritance possible without a hefty tax bill, you first need to determine if life insurance proceeds will push your estate value above the exemption level (approximately $11.18 million - $22.36 million for a married couple - as of 2018). If this is the case, you may want to consider an irrevocable life insurance trust (ILIT).

Adding an ILIT to your financial plan can help minimize some of the potential financial burden your loved ones could face one day. Giving ownership of your life insurance policy to an ILIT  means it pays the premiums and distributes the death benefit to your beneficiaries when the inevitable happens. By doing so, you are removing the death benefit from your estate and ideally dropping your estate value below the exemption level, preventing your family from receiving a costly tax bill from the government.

Though it may sound foolproof, it’s important to do your due diligence when setting up an ILIT so that you’re making a prudent investment, because making changes to an irrevocable trust is quite complicated. You’ll need to ensure that you have selected a trustee that understands their fiduciary responsibilities and the importance of ongoing policy performance monitoring. Trustees who monitor policy performance are better equipped to make corrective actions when a policy is failing to meet the trust objectives. In addition to verifying the policy is meeting the predetermined objectives of the trust, the trustee also needs to make sure the trust is managed properly. Even seemingly small, innocent mistakes in ILIT maintenance can prompt the IRS to challenge the validity of the trust which could lead to the taxation of the insurance proceeds.

Keep in mind that once you set up an ILIT, you are committed to its permanence. Be sure that the policy and the trust will perform as intended and provide you with peace of mind in knowing that your beneficiaries will not bear the burden of substantial estate tax fees upon your death.

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