How Irrevocable Life Insurance Trusts Provide Protection From Taxes and Liability

Many people don’t realize that the proceeds of a South Florida life insurance policy are added to your estate for estate tax purposes if the policy is owned by the deceased during their last 3 years of life. This is the case for over 90 percent of all life insurance policies. While the beneficiary is not taxed on the proceeds directly, the estate will be taxed at a level of 55 percent beginning in 2011. Most of the time, the beneficiary of the life insurance is also the representative of the estate. This means that the government can tax your family coming and going if your plan is not structured properly.

Due to the massive tax implications, an Irrevocable Life Insurance Trust (“ILIT”) is quite useful for South Florida estate planning purposes. An ILIT a legal instrument drafted by a South Florida estate planning attorney for the purpose of removing the life insurance from your estate in order to reduce taxes and increase asset protection. You may designate your spouse, child, or other appropriate party as the beneficiary of the trust.

You may also provide detailed directions to the trustee of the ILIT, including how the life insurance payout should be distributed, when the trustee should make payments, loans, or investments, what to do with the family business, who receives the assets at the death or disability of your original beneficiaries, and when to terminate the trust. The ILIT gives you control of the money from beyond the grave and protects your children from unnecessary liability.

As you can see, the structuring of your life insurance policy so that the ILIT holds the life insurance benefit is useful to achieve a number of goals, including:

1. limiting or eliminating the estate tax;
2. increasing the level of assets available to your spouse, children, and other loved ones or entities after you are gone; and
3. providing extra liquidity to a cash strapped estate or business.

Since the ILIT is a separate South Florida legal entity that is outside your estate, the IRS is unable to levy an estate tax on the assets within the ILIT since they are out of your control. Due to the fact that you are able to lay out all of your goals and desires in the trust document, and because normally the only asset inside the trust during your lifetime is your life insurance, it is logical to trade off giving up control in exchange for all of the tax benefits. The trustee will be the applicant, owner, and beneficiary of your life insurance, so the proceeds will never pass through your taxable estate and the estate tax will be reduced by 55 percent of the life insurance benefit total.

Having your spouse or child own and act as the beneficiaries of a South Florida life insurance policy on your life is another way to avoid the estate tax on your life; however, the ILIT has the added benefit of also keeping the undistributed proceeds out of the taxable estates of your beneficiaries. Properly planned ILITs will limit or eliminate estate taxes and generation skipping taxes for multiple generations.

An ILIT can also help you increase the assets available for your beneficiaries because it makes it easy to own one or more policies of life insurance. The South Florida trustee has the trust document as an efficient road map to follow concerning the purchase, premium payments and distribution of the proceeds. The ILIT infuses cash into your estate by making distributions, purchases, or loans as needed. The trustee of the ILIT makes appropriate distributions of cash proceeds to cover debts, taxes, and funeral expenses. The trustee could even purchase some or all of the business with the cash proceeds and professionally run the business until the children were old enough to take over. The trustee could also make appropriate loans to the spouse, children, and business.