Do you currently own a life insurance policy? Unless it has been put into a special trust (called an irrevocable life insurance trust, or ILIT), then at your death the proceeds from the policy are added to your estate for estate tax purposes. Also, the proceeds are shielded from creditors of your estate. (Also, any heirs of your estate who might be tempted to go on a wild spending spree and waste the proceeds on frivolous things.)
Normally the technique of using an ILIT is to put an existing life insurance policy into one, but you could also put money into an ILIT and direct it to purchase a life insurance policy on you. The heirs of the ILIT can be anybody you want to name. The trustee appointed to administer your ILIT can be given specific instructions on how and when to distribute the life insurance proceeds.
To fund the annual premiums, you could either gift an additional asset to the ILIT to be used to pay the life insurance premiums, or better yet, you could just pay the annual premiums and that amount is considered a gift each year. There is a goofy reporting rule when you make a gift to an ILIT. It’s called a “Crummy Letter.” Basically, you must document to the heirs of the ILIT and of your estate, that you are giving some of their inheritance to the ILIT. Believe it or not, those heirs have a temporary veto power if they choose to exercise it. (For a certain short period of time, then they are considered to have forfeited their right to veto the gift to the ILIT.)
The current taxable estate exemption is just over $12 million, but it is scheduled to revert to $5 million in 2026. When you figure in fair market values of personal homes, retirement holdings, investments, etc. many will find they are bumping into that $5 million limit. Add on a large life insurance payout, and the estate could become taxable, at a top 40% tax rate! Ouch!
Another important facet of this ILIT solution is the “irrevocable” part. That means you can’t change your mind later and unravel the ILIT. So before creating an ILIT, make sure that is what you want to do with your life insurance policy.
Here’s an example of the potential estate tax savings. Let’s say its 2026 and you hold a $1 million life insurance policy. Your taxable estate before counting the life insurance comes to $5 million. If your life insurance policy is NOT in an ILIT, then your estate would have to pay about $400,000 in estate taxes. If that life insurance policy is in an ILIT, they your estate would pay $0 in estate tax. What a deal!
Have you heard? Prov 13:22 says, “A good man leaves an inheritance to his children’s children, but the sinner’s wealth is laid up for the righteous.”
Kelly Bullis is a Certified Public Accountant in Carson City. Contact him at 882-4459. On the web at BullisAndCo.com. Also on Facebook.
