Consider Adding an ILIT to Your Estate Plan to Minimize Estate Tax



One important goal of effective estate planning is to minimize the amount of tax that your estate will be subject to upon your death. If the value of your assets at your death exceeds a threshold amount, your estate will be subject to federal estate tax and potentially state estate tax as well, depending on the state in which you reside at your death. Currently, twelve states (including Illinois) and the District of Columbia impose a state estate tax in addition to any federal estate tax due. Currently, the Illinois estate tax exemption is $4 million per individual, which means a person can transfer up to $4 million worth of assets at death without incurring Illinois estate tax. The current federal estate tax exemption, put in place in 2017 by the Tax Cuts and Jobs Act (TCJA), is $13.61 million per individual; however, this amount is scheduled to “sunset” at the end of 2025 and revert to pre-TCJA levels, which is estimated to be around $7 million per individual (adjusted for inflation).

While many individuals think that the value of their estate will never exceed the federal and/or state estate tax exemption levels, often people don’t realize that life insurance policies are included in the value of one’s estate for estate tax purposes. Accordingly, owning a life insurance policy or policies with significant value can often cause an individual’s estate to be valued above the current estate tax exemption levels. Additionally, the fact that the federal estate tax exemption is set to sunset at the end of 2025 could further reduce the amount of assets that an individual can pass on tax free. Federal and state estate taxes are paid from the assets of your estate before the remaining assets can be distributed to your beneficiaries. 

As a result, now is a good time to consider implementing strategies for reducing the value of your estate so you can minimize estate taxes and maximize your gifts to your loved ones. One effective strategy for reducing the value of one’s estate for estate tax purposes is to prepare an Irrevocable Life Insurance Trust, or “ILIT”, as part of your estate plan. 

Simply put, an ILIT is a special type of trust established while the insured is alive, set up to hold and manage one or more life insurance policies—either term or permanent. An ILIT is an “irrevocable” trust, meaning that once it is established, the grantor (i.e., the one who creates the trust) cannot modify or dissolve it, effectively relinquishing control over all assets titled to the trust. The ILIT is then managed by a trustee, who is responsible for paying the premiums and overseeing the policy. Upon the insured’s death, the policy’s death benefit is paid out to the ILIT directly, and the trustee distributes these funds according to the terms set out in the trust document.

One of the primary benefits of an ILIT is its ability to reduce the grantor's taxable estate. Since the ILIT is a separate legal entity, once the insurance policy is transferred into the trust it is no longer considered part of the grantor’s estate. This means that when the death benefit from the policy is paid out into the trust, it will not be subject to any estate taxes, which can significantly lower the grantor’s overall estate tax liability. Additionally, contributions made to the ILIT, such as premium payments, may be treated as gifts to the trust’s beneficiaries. When properly structured, these contributions can take advantage of the annual gift tax exclusion and lifetime gift tax exemption, reducing potential gift tax liabilities. Although, of course, there are limits and certain notices to beneficiaries required when contributions to the ILIT are made—always consult your attorney and financial advisor before setting up and contributing to these trusts.

The ILIT also provides liquidity to the estate, offering funds to cover estate taxes or other expenses without the need to sell other estate assets. Even better, since the ILIT is not subject to probate, the insurance proceeds are distributed directly to the beneficiaries, bypassing the potentially lengthy and costly probate process (which, trust me, you always want to avoid if possible).

The ILIT can be funded with a new life insurance policy purchased by the ILIT or by transferring an existing policy; however, it’s important to note that the insured must survive the transfer of an existing policy by a least three years to avoid the policy proceeds being included in his/her taxable estate at death.

If you would like to discuss adding an ILIT to your estate plan, Lavelle Law offers a free estate planning consultation to get this process underway and answer any questions you may have about your unique situation. ILIT or no ILIT, everyone needs an estate plan to make sure that they and their family are protected in the event of unexpected death or incapacity. If you’d like to get your estate plan started or add an ILIT to an existing plan, please do not hesitate to contact me at jluthringshausen@lavellelaw.com or (224) 836-6176.