Estate Planning: Irrevocable Life Insurance Trust - T. Rowe Price

An irrevocable life insurance trust is used to help avoid estate taxes on the benefits paid on sizable life insurance policies. The death benefits of your policy may increase your taxable estate above the federal estate tax exemption amount and then be subject to considerable estate taxes. By placing existing policies that you own on your life in an irrevocable trust or by having the trustee purchase the insurance initially, the death benefits will not be part of your taxable estate (provided certain conditions are met). The benefits paid by the life insurance policy(ies) in the trust then can pass directly to your beneficiaries or be held in further trust.

The IRS imposes strict rules on these trusts in order for the assets to be excluded from your taxable estate. To ensure proper drafting, consult with a professional advisor before creating and funding an irrevocable trust of this kind.

Some of the IRS rules include:

  • You cannot be the trustee of this trust.
  • You must find a suitable trustee willing to serve.
  • You cannot change the terms of the trust, including the beneficiaries you named originally.
  • When you fund the trust by transferring existing policies to the trust, you
    are deemed to be making a gift of the policies based on their cash value
    at the time of transfer. In some instances, you may have to use some of your lifetime gift tax exemption to avoid paying gift taxes for the year that the trust is funded. Also, if you die within three years of the date these existing policies are transferred to the trust, the existing policies' face value will be included in the value of your taxable estate.
  • When you fund the trust with cash to be used to buy new policies, as well as to pay annual premiums, you are deemed to be making a gift in the amount of the transferred cash. Fortunately, the three-year holding rule concerning funding the trust with existing policies will not apply. Often, the person funding the trust seeks to make gifts up to the annual gift tax exclusion amounts to the beneficiaries of the trust. These are then used by the trustee to pay insurance premiums each year.