Irrevocable Life Insurance Trusts (ILITs) are used extensively in sophisticated estate planning because they remove assets from an individual's estate while allowing a certain degree of control by the maker. Properly designed and implemented, an ILIT can provide a surprisingly high degree of flexibility coupled with significant estate planning benefits.

Life insurance proceeds are, with few exceptions, free of all income tax. However, many people incorrectly believe that life insurance is also exempt from federal estate tax. Life insurance can be exempt, but if the insured has any rights or powers over the policy, the proceeds will be included in his or her estate and be subject to federal estate tax.
To avoid the federal estate tax, many people have their life insurance owned by a spouse, children, or others; then upon the death of the insured the policy proceeds are paid to the owner's beneficiaries. However, several problems could arise with this plan, including loss of control, inclusion of the policy in the estate of the policy owner, and possibly having the proceeds treated as a gift to the beneficiaries. To solve these problems, the life insurance policy can be purchased by, or contributed to, an irrevocable life insurance trust (ILIT).

An ILIT with one grantor is called an individual trust. An ILIT with two or more grantors is called a joint trust. A joint ILIT generally owns a popular type of policy known as a last-to-die, second-to-die, or survivorship policy. This type of policy basically insures a married couple, pays off at the second death, and costs less than individual policies. Since a last-to-die policy pays when the second spouse dies, it is the perfect arrangement when the purpose of the insurance is to pay estate taxes upon the death of the second spouse.

Other benefits of an ILIT are: 1) it could shelter life insurance proceeds from federal estate tax for more than one generation, 2) allows gifts to the trust (to pay the premiums) to qualify as :"present gifts" for the $10,000 annual gift tax exclusion, 3) permits a grantor to protecti heirs and even make gifts with "strings attached", 4) shelters cash values and proceeds from the claims of creditors and ex-spouses, and 5) could provide flexibility for unforeseen events such as the death of a beneficiary. There are many estates that can utilize an ILIT to provide substantial proceeds to beneficiaries upon the death of the grantor. While they are fairly easy to set up, there are many aspects that need to be considered.

I highly recommend consulting an estate planning attorney to thoroughly review and discuss all options. I also recommend a few books such as "Disinherit the IRS", by E. Michael Kilbourn, ChFC. Excerpts for this article were taken from this book. It is easy to read, and full of ideas and plans to reduce the potential tax bite caused by death. The book jacket says it clearly: "Don't die until you've read this book!" The same can be said for all estate planning.

Special thanks to several persons and publications for information contained in this issue. Thanks to the Illinois Soybean Association,. the Illinois Corn Growers Association and Illinois Corn Marketing Board, the National Cattlemen's Beef Board and National Cattlemen's Beef Association, Eco Golf, LLC, Columbus, IN, the National Pork Producers Council, and author E. Michael Kilbourn, ChFC and his book, "Disinherit the IRS".