Protect Your Legacy: How ILITs Shield Beneficiaries

Summary

Due to changes in retirement rules, it’s important to review your financial plan to mitigate potential tax burdens on beneficiaries; an ILT is a strategy for protecting assets and minimizing liabilities.

Protect Your Legacy

If you haven’t revisited your financial plan in the last several years, you should. The SECURE Act has made substantial updates to retirement rules. These rules could impact your strategy for retirement. One of the biggest changes requires that beneficiaries empty out all inherited retirement accounts within 10 years of the account owner’s death. This can result in significant tax liabilities for your beneficiaries. One way to avoid significant tax ramifications is to establish an irrevocable life insurance trust (ILIT).

How does an ILIT work?

An ILIT is a type of trust that governs the management and distribution of a life insurance policy – yes, you can put a life insurance policy in a trust, thereby protecting your proceeds, and your beneficiaries on your death. Since this trust is irrevocable (meaning the grantor no longer has ownership of the assets in the trust), it can only be changed in limited circumstances once the irrevocable trust is set up. The grantor, you in this case, can purchase a life insurance policy and list the ILIT as the owner of the policy or transfer ownership of an existing life insurance policy to the ILIT. In this way, the grantor is essentially gifting the annual life insurance premium amount to the ILIT.

A key benefit of this type of trust is that when the grantor/life insurance policy owner dies, the proceeds from the life insurance policy are paid to the ILIT and those funds are distributed to the beneficiaries according to the terms of the trust. As a reminder, many trusts are created to help minimize taxes for your estate – and this is no different.

A properly administered ILIT removes the value of the life insurance proceeds from the grantor’s estate so that the grantor has reduced estate assets (and therefore pay less taxes on these assets). This exclusion is significant for those who anticipate having estate tax liability, as the ILIT can provide necessary funds to cover estate taxes and final expenses, and the ILIT is excluded from estate taxes. If the requirements of the ILIT have been met, the life insurance policy passes tax free to both the decedent’s (grantor’s) estate and the beneficiaries.

Should I consider setting up an ILIT?

Since an ILIT requires a life insurance policy, you should consider whether you qualify and are eligible, given your age and current medical conditions. If you can purchase a life insurance policy, here are some other considerations:

  • Your net worth exceeds, or will likely exceed, the applicable estate tax exclusion amount at the state or federal level. This is as low as $1 million in some states.
  • You have tax-deferred retirement assets, such as traditional IRAs and 401(k)s that you hope will benefit your loved ones, especially if Roth conversions or charitable giving would not be appropriate options for you.
  • If there is gross income of $100 or more in the ILIT, a trust return, form 1041 is needed annually.
  • Form 709 gift tax returns are needed to disclose gifts to the ILIT for purposes of paying insurance premiums, taxes, and other needed expenses of the trust.
  • Depending on the size and make up of the policy, Crummey provisions for policy beneficiaries can help with needed gifting to increase annual exclusions.

If you have further questions or are ready to set up an ILIT as part of your comprehensive estate plan, please contact your advisor. If you are not currently a client and have questions, let’s talk.

Mercer Advisors Inc. is a parent company of Mercer Global Advisors Inc. and is not involved with investment services. Mercer Global Advisors Inc. (“Mercer Advisors”) is registered as an investment advisor with the SEC. The firm only transacts business in states where it is properly registered or is excluded or exempted from registration requirements.

All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change. The information is believed to be accurate, but is not guaranteed or warranted by Mercer Advisors. Content, research, tools, and stock or option symbols are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. For financial planning advice specific to your circumstances, talk to a qualified professional at Mercer Advisors.

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