While William Shakespeare once penned, “To be or not to be, that is the question” – when consulting on life insurance planning options, we field a similar question from clients, “To ILIT or not to ILIT?” Ultimately, should an Irrevocable Life Insurance Trust (ILIT) own my life insurance policy?
With a new year in full swing, major political changes in the federal government and uncertainty surrounding the upcoming sunset of the Tax Cut and Jobs Act at the end of 2025, clients are seeking guidance on how best to balance estate planning objectives with flexibility. Faced with a potential 40% tax on assets over the federal estate exemption, clients are asking if the use of an ILIT is right for them.
Specifically, clients in their late forties and early fifties considering retirement, selling their businesses or evaluating the financial legacy they want to leave for future generations, want to know how to maximize life insurance’s unique tax-advantaged status, not exacerbate a federal estate liability, and maintain flexibility with so much time and uncertainty ahead.
Below is a brief framework for those considering using an ILIT as an owner of their life insurance:
1. Purpose: Is the life insurance intended for purely estate planning purposes and not to replace income, pay off debt or intended to be a supplemental source for tax-advantaged retirement income?
2. Taxes: Due to the size of your estate (or the projected size of your estate), does the life insurance as currently owned increase your federal estate tax liability? If the life insurance proceeds are considered part of your gross federal estate, will 40% of the proceeds effectively be lost in taxes to Uncle Sam? The federal estate tax exemption has changed numerous times over the past 20 years, and if history repeats itself, it’s fair to assume that it may change again (and again) during a client’s lifetime.
3. Control: Are you willing to give up legal control of this asset? Policies inside an ILIT are no longer owned by the insured. This is a big one for our younger clients. It is not advisable nor enjoyable to try to recapture a life insurance policy and its cash value from an irrevocable trust - emphasis on IRREVOCABLE. For our clients with a lot of life ahead of them, flexibility is not totally lost, but it is severely hampered with an ILIT.
4. Logistics: If you don’t like following a set of prescribed rules and keeping a paper trail, you might need to re-think the ILIT route. As the insured, but not the owner of the policy (remember, the ILIT owns the policy), you make gifts to the trust so the trust can then pay the premiums. Things like setting up a trust account, drafting trust language, deciding on trust beneficiaries, sending out Crummey withdrawal notices, etc. take time and effort. If you can see past the logistics, don’t forget #5.
5. Cost: From paying your attorney to draft the trust, sending out the Crummey notices, paying the premiums and hiring a trustee to pay those premiums, time and money will be allocated to this process. A thoughtful, experienced estate planning attorney, a competent tax-advisor and a professional trustee are worth their weight in gold.
At Rose Street Advisors, we aim to provide insight and perspective that helps our clients make the best decisions for their specific situations. If you would like to talk further about how life insurance can protect what's important to you and positively impact your planning objectives, we are here to help.