Setting Up A Massachusetts Irrevocable Life Insurance Trusts (ILIT)

Outside of health and auto insurance, life insurance is one of the most common financial products bought in America. An insurance company will provide a lump-sum payment to beneficiaries at the time of the insured individual’s death in exchange for premium payments. The funds provided by life insurance are designed to replace a breadwinner’s earnings and can be used to meet family goals such as covering burial costs, funding a child’s college education or providing liquidity to pay for estate taxes.

What many individuals don’t realize is that the proceeds from a life insurance policy could be subject to an estate tax. Thankfully, there are ways to avoid estate tax on life insurance proceeds. The formation of an irrevocable life insurance trust is one such way to escape taxes.

What Is An Irrevocable Life Insurance Trust?

An irrevocable life insurance trust is a type of trust created to own life insurance policies outside of your estate. An existing policy can be transferred to an irrevocable life insurance trust, or the trust can purchase a policy directly. A trustee must be appointed to become the “owner” of the policy.

As the grantor/creator of an irrevocable trust, you will not be able to serve as trustee. Once the trust is formed and funded, you relinquish any rights to modify or dissolve the trust or the insurance policy(ies) owned by the trust. Your adult children, a friend, a family member, a financial institution, or your estate planning attorney can all serve as trustee. The trustee of your ILIT will be responsible for:

  • Maintaining the policy
  • Managing an ILIT checking account
  • Accepting gifts from you for the premium payments
  • Providing notice to the lifetime beneficiaries of the gift and their right to withdrawal the gift
  • Paying the premium each year in a timely manner
  • Collecting and distributing the life insurance proceeds in accordance with the ILIT’s terms at the time of your death

Benefits Of An Irrevocable Life Insurance Trust

Irrevocable life insurance trusts solve the goal of reducing estate taxes and providing liquidity to pay taxes and expenses. The trust ensures that your beneficiaries receive the largest distributions possible from your life insurance proceeds.

The amount of insurance that justifies the creation of an ILIT can vary depending on an individual’s financial circumstances. The exemption amount for the Massachusetts estate tax is $1 million. Typically, the value of your estate combined with the balance of your policy’s death benefits could easily push your estate into the taxable range. Your life insurance policy could also increase a federally taxable estate. In these cases, the formation of an ILIT makes sense. Additionally, an ILIT can be used to provide a benefit to your family or other beneficiaries, if the majority of the taxable portion of your estate is designated to charities.

Distribution Of An Irrevocable Life Insurance Trust

The trust itself is normally designated as the primary beneficiary of the life insurance policy. Once you die, your death benefits will be deposited into the trust and held for the individuals you’ve named in your trust documents. If the proceeds are held for your spouse, your spouse will receive incremental payments rather than a lump sum. Unlike a lump sum, the incremental payments wouldn’t be taxed as part of your spouse’s eventual estate (assuming the money wasn’t depleted).

Potential Complications Of An ILIT

It’s imperative to plan ahead and set up an irrevocable life insurance trust as soon as possible. If you die within three years of transferring an existing life insurance policy to your ILIT, the IRS or Massachusetts will still include the proceeds in your estate for estate-tax purposes. If you create an irrevocable life insurance trust before you obtain the insurance policy, then you can avoid the three year look-back period.

Your contributions to the policy could also be subject to gift taxes. However, gift tax can be avoided if your trustee sends out a “Crummey” letter every time you transfer money to the trust. The letter will let beneficiaries know that they can ask for their share of the payment now rather than later. If your beneficiaries have immediate access to the money, the gift tax won’t apply.

Dissolving An ILIT

As the name implies, an irrevocable life insurance trust cannot be revoked once created. However, there is a way to dissolve an ILIT should you change your mind. Ongoing premium payments are required to keep the policy in effect. To cancel the trust, you can simply stop making premium payments.

Form An Irrevocable Life Insurance Trust With A Massachusetts Estate Planning Attorney

The estate planning attorneys at Eckert Byrne LLC can help you form an irrevocable life insurance trust. It’s important to start building your legacy plan now and maximize the benefit your beneficiaries can receive from your life insurance policy. Eckert Byrne LLC takes a comprehensive and holistic approach to estate planning to ensure your goals are met efficiently and effectively. Contact Eckert Byrne LLC by filling out an online form or calling (855) 743-3136 to schedule an initial consultation.

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