What is an irrevocable life insurance trust (ILIT)?

An irrevocable life insurance trust, is commonly referred to as an “ILIT” (pronounced "eye-lit"). It is a special trust designed to own a life insurance policy with the idea being that if the trust owns the life insurance policy at time of death instead of the insured there will be significant estate tax savings.

The main advantage of an ILIT is that you can create an instant estate for a beneficiary (the policy's death benefit). Another large advantage is that an ILIT may potentially save estate taxes by keeping the insurance policy and the proceeds of the policy out of your estate.

Another large advantage is that your ILIT can purchase illiquid assets from your estate, providing liquidity to pay for estate taxes. But there are disadvantages.

The chief disadvantage of an ILIT is in its name: it is irrevocable.

What does irrevocable mean? It means that you can’t come back and change your mind once the trust is formed. For example, if you originally name your three children and now want to remove a child, you cannot. The trust is set in stone. It even means you can’t change your mind and get the money you placed into the trust back out of the trust, no matter the reason. Even if you have to have that money, it’s no longer legally yours and you have no right to it.

Further, you can’t use the life insurance policy as collateral for a loan or to borrow against it. While it’s possible to transfer existing life insurance policies into the trust under very specific circumstances, there is a look-back period that you have to remain alive in order for the transferred policies to be considered out of your estate. There are also a lot of ramifications on how to fund the life insurance trust as there are estate and gift tax implications on funding the trust. You also have to find someone other than yourself to be the trustee of the trust and you may need to pay them for this service. And finally, they cost more legal fees than many other planning devices.

While there are many negatives to an ILIT, ILITs can make up for these negatives by allowing you to pass large gifts tax free to your desired beneficiaries.