Life insurance is frequently an integral part of an estate plan. Insurance proceeds provide financial support for family members and dependents in the event of the insured’s untimely death. Life insurance is also used to provide money to pay estate taxes or other expenses occasioned by the insured’s death, particularly in situations where the insured owned a business or a vacation property. Without insurance proceeds, the family may be forced to sell assets they would rather retain in order to pay expenses. For business owners, life insurance provides the liquidity needed to fund buy-sell agreements.

Quite often life insurance represents a significant portion of an individual’s assets. The proceeds of a life insurance policy are subject to estate tax in the insured’s estate if (1) the policy is payable to or for the benefit of her estate; (2) a beneficiary other than the estate is entitled to the proceeds, but the insured held “incidents of ownership” of the policy at the time of her death; or (3) the insured transferred the policy to another within three years of the insured’s death. Proper planning can minimize the significant estate tax consequences that may result when a person dies owning a life insurance policy.

An irrevocable life insurance trust (ILIT) is a common tool for keeping the proceeds of a life insurance policy from being subject to estate tax in the insured’s estate. The ILIT is designated as the owner of the policy and the proceeds of the policy are payable to the ILIT, which provides the framework for the ultimate distribution of the funds to the desired beneficiaries. Ideally, an ILIT is created by having the insured contribute cash to the ILIT. The trustee then uses the cash to buy insurance on the insured’s life. But an ILIT can also be created for existing policies, with the insured-owner transferring the policy to the trust. This is often done in cases where, due to the insured’s age or health, purchasing a new policy on the insured’s life may be cost prohibitive.

A properly planned and drafted ILIT can accomplish a variety of financial goals in a tax advantaged manner.