Eliminate Taxes Forever using an Irrevocable Life Insurance Trust

FinanceWealth-Building

  • Author Thomas Swenson, J.d.
  • Published December 16, 2022
  • Word count 702

An irrevocable life insurance trust (ILIT) is simply an irrevocable trust that owns a life insurance policy. A dynasty trust, also known as a GST, legacy or perpetual trust, is a flexible irrevocable trust that a trust grantor funds using lifetime exemptions for gift & estate and GST taxes. An irrevocable life insurance dynasty trust (dynasty ILIT) can provide asset protection, wealth management and wealth accumulation for many generations, or even perpetually. A dynasty ILIT grows wealth tax-free, provides asset protection, and makes distributions to beneficiaries free of gift and estate taxes forever — a good way to protect hard-earned family wealth against punitive taxes, divorce and frivolous lawsuits.

When trust assets are invested in a life insurance policy, no income or capital gains taxes are paid on investment growth, and insurance proceeds pass income-tax free to the trust (IRC § 7702). Further, as noted above, there are no gift, estate, or GST taxes, not ever. Accordingly, trust assets continually invested in life insurance policies can grow and be distributed to beneficiaries completely free of taxes perpetually.

Irrevocable life insurance trusts (ILITs) are well-known estate planning vehicles, often used to generate sufficient funds to pay expected estate taxes. Funding an ILIT requires a grantor making a completed gift to the trust (making the trust “irrevocable”) and allocation of a corresponding portion of the grantor’s lifetime gift and estate tax exemption to the trust. A life insurance dynasty trust is an ILIT to which the grantor also allocates a portion of the lifetime GSTT (generation skipping transfer tax) exemption, thereby making the trust perpetually exempt from estate and GST taxes.

Different types of life insurance policies may be considered for a dynasty ILIT, as long as a policy meets the definition of life insurance provided in the Internal Revenue Code (IRC).

Generally, for tax-free retirement income, living benefits and death benefit, this author currently recommends a so-called Indexed Universal Life (IUL) insurance policy, specially designed to maximize cash-value growth and minimize death benefit. A well-designed, standard indexed universal life insurance (IUL) policy provides sustained, market-indexed growth and minimal risk (i.e., no exposure to market downturns).

An alternative to IUL is private placement life insurance (PPLI). PPLI is a variable policy and, therefore, may provide better investment returns (but with market risk) than conventional, non-variable domestic IUL life insurance. PPLI is protected in segregated accounts separate from the general fund of the insurance company. Foreign-based PPLI has advantages over domestic PPLI. It has lower minimum premium commitments (min. premium commitment usu. $1 million), and has lower start-up fees and carrying costs. In contrast to foreign PPLI, domestic PPLI requires a minimum premium commitment of $5 million or more, only in cash, has higher fees, and is subject to state-imposed investment restrictions.

In contrast to PPLI, domestic non-variable IUL policies mentioned above do not directly own investment assets (e.g., stock equity, mutual funds) in segregated accounts; rather, the insurer invests funds and credits the policy annually depending on performance of the insurer’s investments. A domestic non-variable IUL policy is generally less risky than PPLI because it is not exposed to negative market downturns, typically having a built-in floor of 0% regardless how badly markets perform. Depending on circumstances, therefore, domestic IUL may actually outperform PPLI.

Currently, the individual federal lifetime gift and estate tax and generation-skipping transfer tax (GSTT) exemptions are $12+ million. Although the U.S. Congress could lower the exemption amounts in the future, if a dynasty trust is already established, it will (presumably) be protected against prospective changes in the tax laws.

Dynasty trusts also protect family wealth against estate or inheritance taxes imposed by some states. For example, New York’s estate tax is 10-16 percent of estate values exceeding $10+ million. Yet, New York and all other states (except Connecticut) have no gift taxes. Thus, “gifting” of assets to a dynasty trust protects them from both federal and state estate (or inheritance) taxes, as well as providing asset protection against possible creditors of trust beneficiaries.

In a self-settled, discretionary asset-protection dynasty ILIT, the grantor can also be a trust beneficiary, if designed properly.

For more detailed information about US tax-law compliant dynasty ILITs, please consult the resources or contact the author for a free consultation.

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