What is the purpose of the irrevocable life insurance trust?

An irrevocable life insurance trust is a legal entity that owns one or more life insurance policies. The trust is generally both the owner and beneficiary of the life insurance policy. When the insured person dies, the trustee makes the life insurance claim and distributes the money according to the wishes outlined in the trust documents.

What is the advantage of having a trust?

An irrevocable life insurance trust is good for someone who wants to keep a life insurance payout out of their estate. Because the trust owns the life insurance policy, the payout is not part of a person’s estate. That means the payout is not subject to inheritance or estate taxes.

Reasons for making a trust include:

  • To keep money out of an estate that would be subject to inheritance and/or estate taxes.
  • To equalize the inheritances of multiple beneficiaries. For example, a family business could pass to one adult child while another receives cash or property of the same value.
  • To make sure the money is managed properly after the death of the insured person. This includes deciding how the trust’s assets are given out and when.

Very few estates are subject to federal estate taxes. In 2019 the first $11.4 million of an estate is not subject to federal estate taxes. Here's a list of state inheritance and estate taxes from the Tax Foundation.

Basics of an irrevocable life insurance trust

How do I fund an irrevocable life insurance trust?

People generally use a permanent life insurance policy, such as whole life insurance or universal life insurance, to fund an irrevocable life insurance trust.

If a couple wants to use a trust to keep money out of an estate, they typically purchase survivorship life insurance, also called a second-to-die policy. This type of policy insures two lives at once and pays out only when both spouses have died.

You could use a term life insurance policy to fund a trust, but that usually doesn’t make sense because you could outlive a term life policy and the trust would be empty.

Can you change the beneficiary of an irrevocable life insurance trust?

You can’t change the beneficiary of an irrevocable life insurance trust. So if you made a trust many years ago that no longer fits your needs, consult a financial planner or attorney. While you may not be able to change the trust beneficiary, there may be ways to set up and fund a new trust.

For example, the current trust could sell the life insurance policy to a new irrevocable trust at fair market value. A professional adviser would need to structure this transfer the right way in order to avoid taxes.

How does a trust pay out?

You can decide how the trust is structured. For example, your heirs could get the full life insurance payout at once, or the trust could spread out payments over time. The trustee could also have the discretion to provide funds when needed; for example, if an heir needs money to start a business.