Irrevocable Life Insurance Trusts (ILITs) offer individuals a powerful tool to protect their assets, provide for their loved ones, and efficiently transfer wealth to future generations. This type of trust combines the benefits of life insurance with the unique advantages of an irrevocable trust structure. The planning specialists at Cedar Point Financial Services LLC work with clients to secure their legacies by helping them to understand ILITs, their incorporation of life insurance, their potential for passing wealth to multiple generations, and their ability to protect assets from creditors.
Understanding Irrevocable Life Insurance Trusts
An ILIT is a legal arrangement in which an individual establishes an irrevocable trust that is intended to purchase and hold a life insurance policy. A life insurance policy is typically purchased by the trust using funds provided by the person who established the trust. These funds are usually in the form of a non-taxable transfer that utilizes that person’s and/or his/her spouse’s lifetime federal estate and gift tax exemption ($12.92 million for an individual and $25.84 million for a married couple in 2023), and/or utilizes each person’s (and/or their spouse’s) annual federal gift tax exemption ($17,000 in 2023). Funds can also be loaned to an ILIT or transferred as a taxable gift.
The life insurance policy is most often written on the life of the person establishing the trust—the grantor, and the policy may also cover his/her spouse. When the insured(s) dies, the death benefit from the life insurance policy is paid out to the trust. Those proceeds are not part of the donor’s estate, not subject to income or estate taxation, and can be used to pay estate taxes as well as to provide for trust beneficiaries.
For over three decades, the team at Cedar Point Financial Services LLC has assisted clients and their advisors in evaluating an estate’s exposure to taxation, and determining if trust-owned life insurance can help in mitigating this exposure to protect and pass wealth downstream.
An ILIT provides several unique benefits, including asset protection, estate tax minimization, and flexibility in wealth transfer planning.
- Estate Tax Efficiency – an ILIT allows policy proceeds to be held outside of the insured's taxable estate, reducing potential estate taxes upon death. This is particularly beneficial for high-net-worth individuals who wish to preserve their wealth for future generations.
- Asset Protection - Since the donor relinquishes control and ownership of the life insurance policies once they are transferred to the trust, those assets are typically shielded from creditors' claims. This protection can be especially significant in situations where the donor faces potential lawsuits, bankruptcy, or other financial liabilities. Individual states often have specific regulations pertaining to the creditor protection that is provided by various types of trusts and life insurance.
- Privacy and Control – Assets in an ILIT avoid probate, and an ILIT owning life insurance offers privacy by keeping the life insurance policy details outside of the public record. Additionally, the trust structure allows the policy owner to maintain control over how and when the proceeds are distributed, ensuring that the insurance benefits are used according to the grantor's wishes.
- Succession Planning – Life insurance inside of an ILIT can be an effective tool for business owners seeking to transfer ownership and control to the next generation. It can provide liquidity to cover estate taxes or facilitate a smooth transition in the event of an owner's death, ensuring the business's continuity.
Cedar Point Financial Services LLC understands that each family’s financial situation is unique. Simply establishing an ILIT and buying a life insurance policy is only a part of the planning process. Other elements such as gift tax analysis, beneficiary designations, policy administration, and understanding the role and powers of a trustee are equally important.
Your Adult Children Are Financially Secure. An ILIT Can Help Your Grandchildren and Beyond.
A Generation Skipping Trust (GST), as the name suggests, is a form of an ILIT that allows assets to bypass one or more generations and be transferred directly to beneficiaries who are two or more generations younger than the grantor. This strategy is particularly useful for individuals who wish to provide for their grandchildren or future descendants, ensuring their long-term financial well-being. Benefits of a GST include:
- Tax Efficiency - Families can potentially avoid or minimize estate taxes that would otherwise be imposed on each generational transfer. By skipping a generation, the assets held within the trust can grow and compound without being subjected to additional taxation. This can result in substantial tax savings, preserving more wealth for future beneficiaries.
- Asset Protection – A GST can shield family assets from potential risks such as divorce, lawsuits, or creditors. Since the assets are held within the trust, they are generally protected from the claims of individual beneficiaries' creditors, ensuring that the intended beneficiaries are the ultimate recipients of the wealth.
- Long-Term Legacy – A GST can be structured to create a lasting legacy that spans generations by providing for the education, healthcare, and general welfare of future beneficiaries, ensuring that their needs are met and their futures secured.
- Ability to Own Life Insurance – By owning life insurance policies on future generations, money can be immediately infused to benefit beneficiaries, equalizing inheritances to provide liquidity to meet tax obligations and other liabilities.
Clients concerned with providing for grandchildren, great-grandchildren and beyond can work with Cedar Point Financial Services LLC to determine if a GST will maintain their family’s legacy for generations to come.
Out of Your Estate But Not Out of Reach
Those considering forming an ILIT are sometimes concerned with the “irrevocable” nature of the trust. Does moving cash and other assets to an ILIT mean a loss of control and access? Fortunately, there are several planning techniques used in tandem with forming an ILIT and buying life insurance that maintain access and asset control for the individual(s) establishing the trust.
Given proper powers, a trustee is able to take tax-free distributions from an ILIT’s life insurance policy and make preferred interest rate loans of this money to the donor/grantor or to the beneficiaries. If made to the donor/grantor, such loans can further reduce an estate since the funds and interest must be recaptured by the trust. Other techniques such as Spousal Lifetime Access Trusts (SLATs) and loan-based private split dollar and intergenerational split-dollar also create flexibility in providing access and control to an ILIT’s assets, including any life insurance.
Cedar Point Financial Services LLC and clients’ legal counsel can provide peace of mind to those establishing ILITs, so that the transfer of assets to the trust does not necessarily keep those assets out of reach.
We Can Help
Combining an ILIT with life insurance is a valuable strategy for families seeking to protect their legacy, preserve wealth, and provide for their loved ones. By leveraging the benefits of an ILIT, trust-owned life insurance offers tax advantages, asset protection, and flexibility in estate planning. The experienced team at Cedar Point Financial Services LLC assists clients and their advisors in combining trust and life insurance solutions.