The term trust refers to a legal arrangement in which a piece of property is held and controlled by one person, known as the trustee, for the benefit of another individual or organization, known as a beneficiary. 

Trust property can include money, real estate, an investment portfolio, or any other such property. There are several different types of trusts that may be set up for almost any terms that the trust’s creator wishes. However, the two main categories of trusts are revocable, and irrevocable.

The terms of a revocable trust may be later amended, changed, or revoked by the “settlor,” i.e. the person creating the trust. Trust settlors may also be known as the “trustor” or “grantor” depending on the person drafting the trust. 

Changes to a revocable trust can be done at any time. In contrast, an irrevocable trust cannot be changed, amended, or revoked once the terms of the trust have been locked in. While this provides a good amount of security for the beneficiary, it creates risk for the settlor. This is due to the fact that it cannot be altered in response to changed circumstances.

It is important to note that the beneficiary of a life insurance policy typically does not have to pay taxes on the money paid out from the death benefit of the life insurance policy, as the money is not counted as taxable income. 

However, if the life insurance benefits are not paid out immediately upon the death of the life insurance premium holder, then their survivors may have to pay an estate tax on the proceeds of the insurance policy if the death benefit is paid to the estate or an interest tax if the proceeds are held by the insurance company after the life insurance premium owner dies. 

One way that a person can avoid having their life insurance proceeds taxed is by forming an irrevocable life insurance trust (“ILIT”). Irrevocable life insurance trusts are essentially trusts that are setup with the trust property being a life insurance policy.

What are Some Benefits and Limitations for Irrevocable Life Insurance Trusts?

Once again, the purpose of an irrevocable life insurance trust is to avoid death benefits paid by a life insurance policy from being taxed. Additionally, irrevocable life insurance trusts allow the owner of the life insurance policy to maintain legal control over the life insurance policy. 

For example, an irrevocable life insurance trust allows the life insurance policy owner to name a trusted person as the trustee to handle the life insurance proceeds for minor children until they reach the age of majority. Typically, the age of majority is 18 years of age but that can vary from state to state. 

Without an irrevocable life insurance trust, if the death benefits are not paid immediately upon the death of the life insurance owner, then the interest gained on the life insurance proceeds would be taxable to the beneficiaries. 

Other benefits of forming an irrevocable life insurance trust include maintaining beneficiaries government benefits. It is important to note that life insurance proceeds may be counted as income for the beneficiary. 

This means that if the beneficiary receives government aid based on their income, such as Medicaid, then the life insurance proceeds may cause them to become ineligible for those benefits. The trustee of an irrevocable life insurance trust can ensure that the proceeds of the life insurance policy do not interfere with the beneficiary’s government aid.

One major disadvantage of an irrevocable life insurance trust is that once the trust is set up, the beneficiaries and trust may not be changed. As mentioned above, this means that there is some risk that comes with forming an irrevocable life insurance trust, with the reward being avoiding taxes on the estate or beneficiaries. 

Additionally, unlike many other trusts which allow beneficiaries to borrow money from the trust, beneficiaries may not borrow money from an irrevocable life insurance trust. Additionally, the owner of the life insurance policy cannot be named as a beneficiary or trustee in the trust, which means that the insured person will need to identify another trusted person to serve as the trustee of the trust. 

Typically, the best party to serve as the trustee for a sizable irrevocable life insurance trust are attorneys or accountants, whose services do not come cheap. However, it is important to note that persons with sizable life insurance policies often find that the tax savings involved in an irrevocable life insurance trust outweigh the costs associated with the expenses of paying a qualified trustee and efforts involved in creating the trust. 

Do I Need an Attorney for an Irrevocable Life Insurance Trust?

As can be seen, creating an irrevocable life insurance trust can be a complicated process, but can result in numerous benefits for the beneficiaries of the trust and the life insurance policy owner. In order to decide whether or not an irrevocable life insurance trust is beneficial to you, you should consult with a well qualified and knowledgeable estate planning attorney

An experienced estate attorney will be able to analyze your estate and life insurance policy, and help you determine your best legal options for avoiding taxes on your estate. Additionally, they will be able to help you set up an irrevocable life insurance trust.