How Does an Irrevocable Life Insurance Trust Work?

An irrevocable life insurance trust is when the trust is the owner of the insurance policy which keeps the proceeds of the life insurance out of the taxable estate. Also, gifts can be made to fund the premiums, which will ultimately reduce the taxable estate. After your death, the trust’s assets – also known as the insurance proceeds – are available to your beneficiaries income-tax-free.

So, how does an irrevocable life insurance trust work?

Firstly, you are the considered the grantor who makes a gift to the irrevocable trust in the amount sufficient to pay the premiums on a life insurance policy.

Annually, the trustee of the trust makes the gifts available to the trust beneficiaries for a limited number of days, in accordance with the Crummey withdrawal provisions. This qualifies the gift for the gift tax annual exclusion treatment.

The Crummey provision is a letter sent out by the trustee that outlines the limited withdrawal period, which is typically 30 days.

If the trust beneficiaries fail to exercise the withdrawal rights for the cash gift, the trustee may use the gifts to pay premiums for the life insurance policy. The trustee is the owner and beneficiary of the policy.

At the death of the grantor/insured, the life insurance death proceeds are rewarded to the beneficiary and are income-tax-free.

The trustee may loan money to purchase assets from the estate, thus providing liquidity to the estate to help pay estate taxes. Also, the trust assets are distributed to the beneficiaries of the trust as directed by the terms of trust document.

If you are listed as a trustee, there are some responsibilities as a trustee that you need to fully understand. As a trustee, you may also become a fiduciary. Both are defined here:


A person to whom property is legally committed in the trust, to be applied either for the benefit of specialized individuals, or for public uses; one who is entrusted with property for the benefit of another; also, a person in whose hands the effects of another are attached in a trustee process (Webster’s Revised Unabridged Dictionary).


A fiduciary is defined as a person who occupies a position of special trust and confidence in handling the affairs of funds of another person (Law and Life Insurance Contract).

Fiduciaries of an irrevocable life insurance trust have the duty to act in the best interest of beneficiaries. Most fiduciary breaches are the result of a lack of prudence. Basically, the fiduciaries do not understand their responsibilities.

Before investing in this type of trust, it is recommended to find a knowledge advisor to assist you or seek out a professional trustee or learn more about life insurance policies and trusts.

Be advised that a significant percentage of advisors and professional trustees do not possess sufficient knowledge to be of significant assistance.

With this in mind, here are some issues to be aware of:

· Is the policy type, face amount, planned premium, rider(s), underwriting class, insured, ownership, and beneficiary designations correct?

· Is the policy performing according to the original illustrations, sale letters, and other materials?

· Are there any surprises – such as unexpected loans, required premiums, or changes in modified endowment contract status?

· Do you have a current in-force illustration? This is the only way to evaluate the policy, which should be issued every two to three years.

· Review the rate of return

· Should the life insurance policy be replaced?

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