Life insurance is a unique asset. It’s a contract where one party – the insurer – promises to pay another party – the policyholder – a fixed cash amount at some point in the future. This future payment is known as a death benefit, or in more general terms, the value of the policy. If you are worried about potential estate taxes and want to keep control over your assets while avoiding probate, an irrevocable life insurance trust can be useful. An irrevocable trust cannot be reversed; once it’s created you can’t take your assets back. A revocable trust, on the other hand, can be revoked at any time by its creator (the grantor).

What is an Irrevocable Life Insurance Trust?

An irrevocable life insurance trust is a trust that owns a life insurance policy. The trust is created by the owner of the policy, also known as the grantor, and is funded with cash or other assets that have value. Typically, the grantor of the trust is the insured person, or the person whose life is being insured, and the beneficiary of the trust is the trust itself. The grantor retains the right to change the beneficiary of the policy at any time but has no control over the policy once it’s placed in an irrevocable life insurance trust. This means that the grantor has no say over who the policy will be paid to once they die. The death benefit of the policy is paid directly from the insurance company to the trust as the beneficiary. This essentially transfers the value of the life insurance policy from the grantor to the trust.

Why use an Irrevocable Life Insurance Trust?

An irrevocable life insurance trust allows the owner of the policy to avoid probate. The death benefit of the policy is essentially paid to the trust, rather than the heirs of the policy owner. The immediate death benefit payment to the trust avoids probate, thereby providing an asset stream to the trust while bypassing probate. The death benefit amount received by the trust is taxed as ordinary income and is not subject to probate taxes. The death benefit of the policy is paid out to the beneficiaries of the trust. The beneficiaries are the people the trust was created for – this can be anyone, such as children or a charity. The death benefit of the policy is not included in the grantor’s estate and therefore does not incur any inheritance tax. This can be beneficial if the grantor had a large amount of assets and was worried about estate taxes.

How do Irrevocable Life Insurance Trusts Work?

The grantor of the trust purchases a life insurance policy using the assets placed in the trust. The life insurance policy is held by the trust and is controlled by the trustee of the trust. The trustee is the person responsible for managing the policy. The policy is usually purchased with a level death benefit, which is typically a death benefit between $100,000 and $500,000. The level death benefit amount remains the same regardless of how old the insured person is. The insured person can choose to purchase a decreasing death benefit policy. A decreasing death benefit policy collects a smaller death benefit at a younger age, potentially saving the insured person money in the long run. The trust must specify the death benefit amount that the policy should pay out to the beneficiaries when the insured person dies. This amount is known as the death benefit proceeds that the trust receives.

Irreversible Risk Clauses and Discretionary Irrevocable Trusts

An irreversible risk clause is a provision in the trust that states the death benefit will be paid to the beneficiaries of the trust if the policyholder dies before the death benefit amount has been collected. This is a common provision in irrevocable life insurance trusts because death benefits are typically paid out over a long period of time. If the insured person dies before the death benefit amount has been collected, the beneficiaries of the trust will receive the death benefit. Normally, the life insurance company has 60 days to determine whether or not the policyholder has died. If the company determines that the policyholder has died, they will pay the death benefit amount to the beneficiaries of the trust. The beneficiaries will then have a specified time period to decide what to do with the death benefit proceeds. This time period is often one year but can vary depending on the company.

When Should You Use an Irrevocable Life Insurance Trust?

An irrevocable life insurance trust is often used when the grantor is worried about estate taxes. This can be common in higher-net-worth individuals who have a large amount of assets and are worried that they may be subject to estate taxes after they die. The death benefit of the policy is not included in the grantor’s estate, so there is no inheritance tax. The trust will receive the death benefit proceeds and can be used to fund various expenses. The expenses can be anything the trustee of the trust decides to fund – this could include maintaining the insured person’s residence or education for their children.

The Bottom Line

An irrevocable life insurance trust is a trust that owns a life insurance policy. The policy is created by the owner of the policy, also known as the grantor, and is funded with cash or other assets that have value. The grantor of the trust purchases a life insurance policy using the assets placed in the trust. The life insurance policy is held by the trust and is controlled by the trustee of the trust. The policy is usually purchased with a level death benefit, which is typically a death benefit between $100,000 and $500,000. The level of death benefit amount remains the same regardless of how old the insured person is. The insured person can choose to purchase a decreasing death benefit policy. A decreasing death benefit policy collects a smaller death benefit at a younger age, potentially saving the insured person money in the long run. The trust must specify the death benefit amount that the policy should pay out to the beneficiaries when the insured person dies. This amount is known as the death benefit proceeds that the trust receives.