The purpose of an irrevocable life insurance trust (ILIT) is to keep the death benefit of life insurance on your life out of your estate so as to eliminate the estate taxes that would rob some of those proceeds when you die.
It keeps it out of your estate by the trust owning the life insurance policy on your life. If you own the life insurance policy on your life, then the policy’s death benefit will be added to your gross estate when you die, and thereby increasing your estate taxes.
You can fund your ILIT with a life insurance policy either by having the ILIT buy – and therefore own – a new policy on your life or have you transfer (i.e. gift) ownership of your existing policy to the ILIT. If you transfer ownership of your own policy you must live three years after the transfer or else the policy remains in your estate at your death.
-Funding a new life insurance policy on you owned by your ILIT:
The trustee of your ILIT will sign the application for the new policy. But, of course, you’ll have to qualify for the insurance policy – if you can.
The ILIT will be the new owner and possibly assigned as the beneficiary in favor of its beneficiaries which you assign. Be sure that ILIT is in existence when the policy is issued so you’re never considered the owner – even temporarily.
The ILIT’s ability to pay premiums can be funded by gifts you make to the ILIT. Remember you can gift up to $14,000 (2014) per year free of gift tax.
-Funding your ILIT with your existing policy:
Here are the steps to take:
* Get an employer identification number (EIN) for the ILIT. You can do this at the IRS website.
* Get and complete: a change of owner/assignment form and a change of beneficiary form from your insurance company. You’ll need to have you -as owner- and the ILIT trustee sign the forms.
* Submit all forms to your insurance company
* Confirm that your insurance company has made the changes.
* Store your ILIT’s policy with the ILIT documents. If premium payments are still due on your transferred policy, the ILIT trustee can pay them with your yearly gift to the ILIT.
Remember that the purchase of life insurance involves costs, fees, expenses and potential surrender charges and depends on the health of the applicant. Not all applicants are insurable at the time they apply. If a policy is structured as a modified endowment contract, withdrawals will be subject to tax as ordinary income and withdrawals prior to age 59 1/2 are subject to a 10% penalty.