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Life insurance trusts, often called ILITs, allow you to protect policy proceeds, reduce estate taxes, and control how funds are managed for your beneficiaries. These trusts are used in Massachusetts estate planning to keep insurance proceeds out of your taxable estate while ensuring the money is handled according to your instructions.
What Is a Life Insurance Trust?
A life insurance trust is an irrevocable trust designed to own and manage one or more life insurance policies. When the trust—not you—owns the policy, the proceeds typically are not included in your taxable estate.
People in Massachusetts consider ILITs to:
- Reduce estate taxes
- Protect insurance proceeds from creditors
- Provide clear instructions for how money is managed and distributed
- Avoid probate for policy proceeds
Because the trust is irrevocable, you cannot change its terms later, so thoughtful planning is key.
How Does a Life Insurance Trust Work?
An ILIT has three main roles:
- Grantor: You create and fund the trust.
- Trustee: Manages the trust and follows your instructions.
- Beneficiaries: Receive money from the trust after your death.
Once created, the trustee purchases a new life insurance policy with the trust as both owner and beneficiary. When you die, the insurance company pays the trustee, who uses the funds to handle taxes, debts, or expenses before distributing remaining assets to your beneficiaries according to the trust terms.
How Does an ILIT Reduce Estate Taxes?
Life insurance proceeds are often one of the largest assets included in a taxable estate. An ILIT helps reduce this burden by shifting ownership of the policy away from you.
Key tax-related benefits include:
- The policy is not counted in your taxable estate if owned by the trust.
- The proceeds can be used to pay estate taxes and expenses without increasing your estate’s value.
- Assets do not have to be sold quickly to raise cash.
- Proceeds pass outside probate and are not subject to income tax.
If you transfer an existing policy into an ILIT, you must live for three years after the transfer for the tax benefits to apply. This rule does not apply when the trust purchases a new policy from the start.
Does an ILIT File a Tax Return?
In many cases, an ILIT must file an annual fiduciary income tax return (Form 1041), but it depends on how the trust is structured and whether it earns income.
An ILIT may need to file if:
- The trust holds assets other than the policy (such as cash or investments)
- The trust earns income that is not distributed in the same year
- The trustee is required to report gifts used to fund premium payments
Your estate planning attorney can explain when returns are required and how to keep the trust in compliance.
Why Not Name Someone Else as Owner of the Policy?
Naming a spouse or child as the owner may seem simple, but it carries risks:
- The policy could be subject to their creditors.
- They could change the beneficiary, surrender the policy, or borrow against it.
- If they die first, the policy value may be included in their taxable estate.
An ILIT avoids these risks and provides long-term stability and instructions for future management.
Who Can Be Beneficiaries of an ILIT?
You can name almost anyone, including:
- A spouse or partner
- Children and grandchildren
- Charities or religious organizations
When the trust is the policy beneficiary, the trustee can manage funds responsibly for young heirs, loved ones with disabilities, or anyone who may need long-term oversight.
How Are Premiums Paid Through an ILIT?
You fund the trust, and the trustee uses those funds to pay the insurance premiums. These contributions can be treated as annual exclusion gifts if the trust beneficiaries receive a notice (called a Crummey Notice) explaining their right to withdraw the gift.
This structure helps avoid gift tax issues and keeps the policy active without increasing your taxable estate.
When Should I Set Up an ILIT?
Many people create ILITs in their 50s or 60s, but you can establish one earlier if your estate plan calls for it. Do not wait until health concerns make it difficult or expensive to obtain life insurance.
Benefits of a Life Insurance Trust
A well-drafted ILIT provides several estate planning advantages:
- Keeps insurance proceeds outside your taxable estate
- Provides immediate liquidity to pay taxes and expenses
- Supports long-term planning for children or vulnerable beneficiaries
- Keeps proceeds out of probate
- Allows you to control how and when funds are distributed
- Prevents court involvement when a beneficiary is incapacitated
A Strong Estate Planning Tool When Used Correctly
ILITs give you structure, predictability, and tax-efficient planning when your estate includes significant life insurance. They work best when aligned with your larger estate plan and supported by guidance from an experienced attorney.
Protecting Your Legacy With a Life Insurance Trust
Creating an ILIT can strengthen your estate plan, reduce tax exposure, and ensure your assets pass the way you intend. We will help you determine whether a life insurance trust fits your goals and prepare a plan that reflects your wishes.
Contact The Law Offices of Patricia Bloom-McDonald to get started.