Email FacebookTwitterMenu burgerClose thin

How an Irrevocable Life Insurance Trust (ILIT) Works


An irrevocable life insurance trust (ILIT) can provide peace of mind as you start your estate planning process. If you have a sizable estate or young beneficiaries, an ILIT can provide control over a life insurance policy that a last will and testament may not. The “irrevocable” part of that trust means that its creator, or grantor, can’t amend it once it’s set up. Such a trust has its benefits, but there are variable to consider before setting it in stone. A financial advisor can help with all your trust needs and more. Consider finding one with SmartAsset’s free financial advisor matching service.

Irrevocable Trust Definition

A revocable trust allows the grantor to make changes or even end the trust if they want to. An irrevocable trust doesn’t allow any changes from the trust creator once it’s been set up. The only people who are allowed to make and approve changes are the beneficiaries. 

Revocable trusts tend to be more common since there’s more flexibility for the trust creator to make changes to the policy. But irrevocable life insurance trusts may still be a good idea if you need one.

A grantor sets up and funds the trust while alive. If there are any gifts or transfers made to the trust, they’re permanent and can’t be changed. The trustee — who is different than the grantor — manages the trust and handles how distributions to beneficiaries are made. 

Irrevocable Trust Uses

SmartAsset: How an Irrevocable Life Insurance Trust (ILIT) Works

As mentioned earlier, irrevocable trusts have some benefits despite their inflexibility.

Lower Estate Taxes

With an irrevocable trust, deaths benefit are not part of your gross estate. That means they aren’t subject to state and federal estate tax. Such a trust can also help cover estate tax costs and other debts as long as the estate makes the purchases, not the grantor. Because the estate is now part of the trust, you’re no longer on the hook for estate taxes.

It’s important to note that while your estate is exempt from estate taxes, they are subjected to your beneficiaries’ estate. That can shift your high tax burden onto them.

Leaving Assets to Minors

Minors might not be responsible or equipped to handling assets, especially large amounts of money.

An irrevocable allows restrictions to be put in place. You can set it up so beneficiaries have to reach a certain age to gain assets or accounts.

Protecting Assets from Creditors

If you think you’re liable for certain legal proceedings, an irrevocable trust can protect you and your family from them. 

Having a high-liability business that can face claims regardless of you living or dying can add stress to your family. With an irrevocable trust, your assets are protected from creditors.

Irrevocable Life Insurance Trust Uses

The IRS notes that life insurance payouts are typically not included among your gross assets. You usually don’t have to report them, but there are exceptions.

If you’ve earned interest on a life insurance payout, any interest you have received is taxable. Also, if a life insurance policy was transferred to you by another person for a sum of money, only the sum you paid is excluded from taxes.

Though the estate tax exemption for 2019 is $11.4 million, an estate of that size could be pushed over the limit by a life insurance payout. State estate tax exemptions also tend to be lower than that amount. By using an ILIT, a grantor can exclude a life insurance payout from the gross estate.

An ILIT would also shield a life insurance payout and your beneficiaries from any legal action against you. Legally, ILITs are not owned by the beneficiaries, which makes them tough for the courts to label as assets. It also makes it almost impossible for creditors to take those funds.

Finally, as mentioned earlier, an ILIT can prevent a life insurance payout from going directly into the hands of a minor. The ILIT can direct those funds to a spouse or to a trustee. That person can be directed to hold onto those funds until a minor reaches adulthood or meets benchmarks you’ve specified.

Irrevocable Life Insurance Trust Downsides

An ILIT has some quirks that may be frustrating during the estate planning process

Some of the tax benefits of an ILIT only kick in if you live three or more years after transferring your life insurance policy to the trust. Otherwise, the IRS will include life insurance proceeds in your estate for estate tax purposes.

The ILIT can purchase the policy and avoid that three-year stipulation. But you’ll have to  fund the trust to pay premiums.

Giving the trust money for that policy may make you subject to gift taxes. However, if you send beneficiaries a letter after each transfer notifying them they don’t have immediate access to the money, gift taxes won’t come into play.

The most glaring downside to an ILIT is that you can’t change it once it’s established. You relinquish control of assets and can’t dissolve the trust unless you simply stop making payment for premiums. Finally, while the trust absolves you of certain tax implication, your beneficiaries may take on a sizable tax burden once they receive your estate.

Bottom Line

SmartAsset: How an Irrevocable Life Insurance Trust (ILIT) Works

An ILIT is a good idea if you have a significant amount of wealth and assets you need to protect after you pass. To avoid hefty estate tax and creditors, as well as set up your family after you pass, an ILIT might work for you.

But they aren’t for everyone. You give up the right to make any changes to the policy once it’s set up. Only the beneficiaries of the trust are allowed to approve changes. If you’d like more control over your afterlife plans, you may want to consider a revocable trust or other legal means instead.

Tips for Estate Planning

  • An irrevocable trust can be tricky even when life insurance isn’t involved. If you’re a bit intimidated by it, consider consulting a financial advisor. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • Want to learn more about estate planning, or even the estate taxes and inheritance laws in your state. SmartAsset’s estate planning guide has lots of information that may be useful to you during the process.

Photo credit: ©, ©, ©