Irrevocable Life Insurance Trusts
An irrevocable life insurance trust (also known as an "ILIT") is a separate taxable entity distinct from the person who establishes it. An ILIT is established through a written trust agreement in which the individual irrevocably transfers cash or an existing insurance policy to the trustee who holds that property for the benefit the individual's chosen beneficiaries, usually the spouse or other family. In most cases, the trust is established first and a new life insurance policy on the life of the individual is purchased by the trustee. In this case, the proceeds of the policy are free of federal estate tax even if the individual dies shortly thereafter. However, if an existing life insurance policy is transferred to the trust, the tax benefits of the ILIT will not be available until three (3) years after the policy is transferred. In the latter case, if death occurs within three years, tax might still be avoided if the individual has left a surviving spouse as the beneficiary and the trust is properly drafted.
It is important for a married couple to avoid violating the "Reciprocal Trust Doctrine" by executing substantially identical trusts benefiting each other. A violation of the Reciprocal Trust Doctrine will result in both trusts being subject to the federal estate tax, defeating the purpose of the ILIT.
Finally, a married couple may find it beneficial to purchase a "second to die" life insurance policy through an ILIT because a "second to die" life insurance policy will provide a large payout upon the death of the second spouse to die for a comparatively low cost.