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For most of us, life insurance is a stand-alone product, a means of monetizing the insured’s life value at the time of his or her death and thereby supplementing his or her estate. However, this benefit can be greatly increased when life insurance is placed in a trust.

Whether the trust is revocable or irrevocable, each goes into effect while you are still alive, although assets placed into an irrevocable trust typically can not be retrieved by you but are not taxed in your estate at death.

Revocable Trusts
Also known as Living Trusts, revocable trusts provide an excellent vehicle to avoid probate which, in turn, reduces legal fees, minimizes privacy issues and puts your bequests into the hands of your heirs more quickly and efficiently.

However, revocable trusts typically will not shield your estate from federal tax, but merely provide benefits while you are alive as noted above and hopefully make for a smoother transition of assets when you die.

Irrevocable Trust
Also known as an Irrecovable Life Insurance Trust, ILITs are specifically created to own life insurance but can own other investments also.
The ILIT becomes both the owner and the beneficiary of one or more life insurance policies typically written on the life of the grantor (the creator of the trust). When properly structured, proceeds from that life insurance are not subject to income tax or estate tax upon the insured’s death. Administration of the ILIT must be done by an independent trustee (not the grantor of the trsut)

Here’s how they work:
The grantor sets up a trust for the benefit of his heirs and funds it through annual cash contributions. The gifting limits, adjusted annually for inflation, are $15,000 per beneficiary for this year (2018). If the grantor were to name three beneficiaries, for example, he or she could gift a total of $45,000 ($15,000 x 3) to the trust in the current year. )If he were married this could be $90,000 per year)
The grantor could also choose to gift all or part the lifetime exemption amount which is currently $11,200,000.

The Power of Life Insurance

Now here’s the power play. Regardless whether the grantor makes annual contributions, or gifts a partial or full lifetime solution, he or she could put that money toward the purchase of life insurance. Why? First of all, the return on investment is guaranteed to be many fold over the total amount of the contributions made. For example, an annual contribution of $45,000 will support as much as a $1,750,000 life insurance benefit for a healthy 70 year old man. Secondly, that benefit will be passed on to the heirs income and estate tax-free.

Indeed, there is not a safer, more profitable way of investing your trust funds than through the purchase of life insurance in an irrevocable life insurance trust.

ILITs have other advantages as well:

1) Liquidity – for estate taxes and other expenses (remember, death benefits are received income and estate tax free by the trust);
2) Equalization of inheritances / transfer of a family business;
3) Creditor Protection – proceeds from life insurance received by the ILIT are protected from creditors with rare exception; and,
4) Asset Management – By using a trusted advisor, trust company or appointed family member as trustee, the ILIT provides effective management of insurance proceeds which in turn provides added peace of mind for the grantor.

Most larger estates will utilize both revocable and irrevocable trusts and some non-taxable estates may still benefit from the revocable trusts.

But in the world of estate planning, the ILIT reigns as one of the most powerful planning tools for minimizing federal estate taxes and / or paying those taxes with tax free life insurance proceeds.

As always, the advice of a wills and estate attorney together with other advisors (CPAs, CFPs, and life insurance experts) is vital in optimizing your estate plan.