An irrevocable life insurance trust is a trust that holds a life insurance policy to prevent estate taxes. The trust is irrevocable, and the grantor cannot withdraw the policy. The trust becomes the beneficiary of the policy, and the grantor cannot change that designation. The grantor cannot borrow against the policy, and the trust holder cannot act as the trustee.
An irrevocable life insurance trust is a type of trust set up to hold a life insurance policy rather than the usual money and property trust. In such a situation, the trust owns the life insurance policy instead of the person who bought the policy and created the trust. Because this type of trust is irrevocable, no one can change or cancel it after it’s created. Likewise, the grantor cannot withdraw the life insurance policy.
Often, people create irrevocable life insurance trusts to prevent their insurance policy proceeds from being subject to estate taxes after their death. Regular life insurance policies are usually subject to these fees. If a person transfers their life insurance policy to a trust, its beneficiaries can benefit from the proceeds without losing large sums to estate taxes.
In some types of trusts, the grantor of the trust may also serve as a trustee. This is not the case with an irrevocable life insurance trust. If the grantor of a trust also acts as a trustee, they may be treated as the trust holder, which would not protect them from estate taxes. The grantor may choose any other person to act as a trustee, including a spouse or children.
There are some potential disadvantages to consider when setting up an irrevocable life insurance trust. One of these concerns the beneficiary of the life insurance policy. The trust becomes the beneficiary of the policy and the grantor loses the right to change that designation. He can establish the beneficiaries of the trust, but if his family circumstances change, he doesn’t have the flexibility to make changes that most people have with life insurance policies.
Another potential downside is that the lender cannot borrow against the life insurance policy once the trust is created. Some people like to have this option available to them in case difficult circumstances arise. If the grantor were entitled to borrow against the policy placed in the irrevocable life insurance trust, he would be deemed the owner of the policy, which would subject the policy proceeds to estate tax.
Some people may even see the irrevocability of this trust as a serious disadvantage. The grantor cannot withdraw the life insurance policy once the trust is established. In the event that you become uninsurable, the life insurance trust may be your only insurance policy. If your life insurance needs change after the trust was created, irrevocability could be an issue.
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