With the estate tax sure to make a comeback next year, estate tax planning is once again at the forefront of many peoples’ minds. And in calculating your gross estate for tax purposes, the IRS includes the value of any life insurance policies you own.
For people whose life insurance policies drive the value of their gross estate into the taxable realm, an Irrevocable Life Insurance Trust (ILIT)can be an effective estate planning tool. How does it work?
You establish an ILIT and name a trustee other than yourself. Then, you transfer ownership of your life insurance policy to the trust, and you name the trust as beneficiary of your life insurance policy.
As part of your trust agreement, you’ll designate trust beneficiaries. These will be your spouse, children, or any other person whom you’d normally designate as beneficiary of your life insurance policy. So, when you pass away, the proceeds of your life insurance policy will go to the trustee, who will then distribute them to the trust beneficiaries according to the instructions contained in the trust agreement.
The ILIT keeps your life insurance policy from being included in your gross estate because, as of the time you transfer the policy to the trustee, you no longer own it. And because the trust is irrevocable, you can’t get the policy back. If you’re married, you can specify in the trust agreement that your life insurance proceeds are to be held in the ILIT after your death and used for the benefit of your spouse during his or her lifetime, and then distributed to your children or other beneficiaries after your spouse passes away. This way, the ILIT avoids estate taxes for your spouse.
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