A life insurance trust—also known as an irrevocable life insurance trust (ILIT)—is a trust that consists of one or more life insurance policies that are payable to the trust upon the death of the insured.
A life insurance trust is usually created by a person (the grantor or settlor) who purchases one or more life insurance policies and places ownership of the policies in the trust, for the benefit of the named beneficiary or beneficiaries. As with other trusts, the trust will designate a trustee who will oversee and manage the trust assets (life insurance policies) during the grantor’s lifetime and following the grantor’s death.
Because a grantor who purchases life insurance policies and places them in a life insurance trust gives up ownership and control of the policies (and cannot revoke the trust) they may avoid having the life insurance policy or policies included in their gross estate at death—which may avoid estate tax liability on the value of the insurance policies.
Section 2042 of the Internal Revenue Code (26 U.S.C. §2042) states that the value of life insurance proceeds insuring your life are included in your gross estate if the proceeds are payable: (1) to your estate, either directly or indirectly, or (2) to named beneficiaries if you possessed any incidents of ownership in the policy at the time of your death.
Laws and Internal Revenue Service (IRS) interpretations may change at any time and a person who owns or is considering purchasing a life insurance policy may want to consult with an estate planning lawyer or financial advisor to try to avoid having the policy included in their gross estate at death.
In Texas, an irrevocable life insurance trust (ILIT) is a legal tool used to exclude life insurance proceeds from the grantor's taxable estate, potentially avoiding estate taxes upon the grantor's death. The grantor, who creates the trust, transfers ownership of one or more life insurance policies into the trust, relinquishing control and ownership over the policies. The trust is managed by a trustee for the benefit of the named beneficiaries. Since the grantor no longer owns the policies, the proceeds are not considered part of the grantor's estate for tax purposes, as long as the grantor did not retain any incidents of ownership. This aligns with Section 2042 of the Internal Revenue Code, which includes life insurance proceeds in the grantor's gross estate if the proceeds are payable to the grantor's estate or if the grantor had any incidents of ownership in the policies. It is advisable for individuals to consult with an attorney specializing in estate planning to navigate the complexities of estate taxes and to ensure that the ILIT is properly structured to achieve the desired tax benefits.
