What You Should Know About Irrevocable Life Insurance Trusts (ILITs)

Have you been asked about irrevocable life insurance trusts (ILITs) and aren’t sure where to start? 

For many insurance brokers, ILITs might sound like a complex and niche aspect of estate planning. However, understanding how ILITs work and the value they bring can open doors for better advising your clients. Whether it’s tax benefits, protecting beneficiaries, or creating a long-term financial strategy, ILITs present a powerful tool for clients planning their estates.

This guide breaks down the key aspects of ILITs, why they matter, and what every insurance broker in New York should know to better serve their clients.

What Is an Irrevocable Life Insurance Trust (ILIT)?

At its core, an irrevocable life insurance trust (ILIT) is a trust created to own a life insurance policy.

What makes a policy “irrevocable”?

A policy is irrevocable when the grantor cannot alter or reclaim the assets once the trust is created. This irreversible nature is what enables the trust to function as a powerful estate planning tool.

An ILIT holds a life insurance policy. It also ensures the eventual payout is handled to meet the grantor’s wishes, free from estate taxes, creditors, and other potential financial pitfalls.

Why Should Insurance Brokers Care About ILITs?

If you’re advising clients on life insurance policies, understanding ILITs can help you offer comprehensive solutions that align with their estate planning goals. An ILIT complements life insurance by increasing its benefits. It’s not just about selling a policy—it’s about creating a broader financial strategy for your clients.

What Are the Main Benefits of an ILIT?

Here’s why ILITs are a critical estate planning tool:

• Estate Tax Exemption 

By moving the life insurance policy into an ILIT, the death benefit is excluded from the taxable estate, potentially saving millions in estate taxes for high-net-worth clients in New York.

• Controlled Payouts 

An ILIT allows detailed instructions on how the funds should be distributed. This is especially useful for beneficiaries who are minors, have disabilities, or exhibit financial irresponsibility.

• Creditor Protection 

Assets held in an ILIT are generally protected from creditors and legal disputes. This ensures that the policy proceeds remain intact for the intended beneficiaries.

• Government Benefit Compatibility 

For beneficiaries receiving Medicaid or other government assistance, an ILIT can ensure distributions won’t interfere with eligibility.

How Does an ILIT Work?

An ILIT owns your client’s life insurance policy. Upon their death, the life insurance proceeds are paid into the trust. The trustee, a person your client designates, manages these proceeds and distributes them per the trust’s instructions.

It’s important to note that ILITs must be irrevocable from the moment they’re created. This means your client relinquishes control of the policy and its proceeds. However, this step is critical for the tax and legal benefits an ILIT provides.

Who Are ILITs Best Suited For?

ILITs are generally recommended for clients with significant wealth or unique estate planning goals. Below are a few ideal candidates:

• Clients with estates near or above the federal estate tax exemption threshold.
• Those looking to protect assets for minors, special needs beneficiaries, or beneficiaries with poor money management skills.
• High-net-worth individuals in second marriages who want to ensure equitable asset distribution among children from different relationships.
• Clients concerned about protecting assets from creditors, lawsuits, or divorces involving their beneficiaries.

Do ILITs Work for Small Estates in New York?

While ILITs are often associated with affluent clients, they also add value to moderate estates. For example, they can help ensure carefully managed payouts or protect smaller inheritances.

What Are the Tax Benefits of an ILIT?

Tax advantages are one of the most significant selling points of an ILIT:

• Estate Tax Exclusion 

Assets in an ILIT are not included in the grantor’s taxable estate. This is crucial for clients with estates exceeding the federal estate tax exemption threshold, which is $11 million (adjusted for inflation) and expected to total $13.8 million in 2025.

• Gift Tax Exemption 

The Crummey letter (a notification sent to trust beneficiaries) can make premiums paid by the grantor eligible for the annual gift tax exclusion, reducing tax liability.

• Generation-Skipping Transfer Tax (GST) Avoidance 

ILITs are ideal for bypassing hefty GST taxes on gifts to grandchildren or younger beneficiaries.

How Do ILITs Support Beneficiaries with Special Needs?

For special needs beneficiaries, receiving a large inheritance can jeopardize their eligibility for government assistance programs. An ILIT allows trustees to make controlled distributions, ensuring funds support the beneficiary without disqualifying them from benefits like Medicaid or Supplemental Security Income (SSI).

Can ILITs Protect Beneficiaries in Legal Disputes?

One of the greatest advantages of an ILIT is asset protection. Because the trust owns the life insurance policy, creditors, divorce settlements, or lawsuits generally cannot touch the trust’s assets. However, note that once proceeds are distributed, they become part of the beneficiary’s assets and may no longer be protected.

What Role Does a Trustee Play in ILITs?

The trustee manages the ILIT, ensuring the terms of the trust are followed. This includes:

• Paying policy premiums using funds provided by the grantor.
• Sending Crummey letters to beneficiaries to satisfy tax rules.
• Distributing proceeds to beneficiaries as outlined in the trust. 

Choosing a responsible, trustworthy individual or institution as the trustee is critical.

What Are the Risks of Setting Up an ILIT?

It’s not all advantages. Some challenges include:

• The irrevocable nature of ILITs means there’s no going back once established.
• Error-filled execution can result in losing tax benefits. Clients must work with experienced legal and tax professionals.
• Correctly timing the life insurance transfer is critical; otherwise, the policy could remain subject to estate taxes.

Do Your Clients Need to Transfer an Existing Policy into the ILIT?

If your client already owns a life insurance policy, it must be transferred to the ILIT at least three years before their death to avoid inclusion in their estate. Alternatively, clients can purchase a new policy with the ILIT as the initial owner.

How Can Insurance Brokers Explain ILITs Effectively?

When discussing ILITs with clients, focus on their core benefits and relate them to the client’s personal goals, whether that’s protecting family wealth, avoiding taxes, or ensuring responsible financial management for beneficiaries.

FAQs About Irrevocable Life Insurance Trusts

1. Can an ILIT be changed after it’s created? 

No, ILITs are irrevocable. Once created, no changes can be made to the trust or its terms.

2. Are ILITs only for wealthy clients? 

No. While ILITs are common among high-net-worth individuals, anyone with specific estate planning goals can benefit, particularly those looking to protect beneficiaries or manage payouts.

3. What’s the impact of an ILIT on estate taxes in New York? 

By excluding the life insurance proceeds from the grantor’s taxable estate, ILITs can significantly reduce estate taxes, which is especially beneficial for estates near or above the exemption threshold.

Take the Next Step with Law Offices of Vlad Portnoy

If your clients have questions about irrevocable life insurance trusts or wish to explore them further, now is the time to act. At the Law Offices of Vlad Portnoy, we help New York residents craft personalized estate plans that ensure security, tax efficiency, and peace of mind. 

Contact us today at 516-518-8586 or email us at [email protected] to schedule a consultation. Together, we can create a plan that delivers lasting protection and legacy for your clients.