An ILIT accomplishes two objectives. First, it removes life insurance death proceeds from your estate and thereby reduces the value of your estate for estate tax purposes. Second, it allows you to direct how the proceeds of your life insurance will pass to your beneficiaries.
A brief example shows how an ILIT can prevent your life insurance from triggering unnecessary estate taxes. As stated earlier, if at the time of your death your property (including life insurance) exceeds the exclusion amount, your estate will have to pay estate taxes; however, if the life insurance is removed from your taxable estate by transferring it to an ILIT, the taxable value of your estate will decrease by the amount of the life insurance removed from it. The smaller your taxable estate the smaller your estate tax burden.
The best thing about ILITs is that they are specially designed to hold life insurance tax-free. The life insurance death proceeds will pass to your chosen beneficiaries estate tax-free because it was owned by the trust – not by you. It is that simple.
Does this sound too good to be true? It is not if the ILIT is properly drafted and implemented! In order to achieve this remarkable result, the ILIT must be drafted very carefully, the life insurance policies must be transferred to the ILIT in a specific manner, and the life insurance premiums must be paid in the correct fashion. Good advice from an experienced estate planning attorney is essential to making sure each of these detailed steps, and others, are done correctly.