If your family will likely incur estate taxes upon your death or want to protect your family after you’re gone, would will want to consider setting up an irrevocable life insurance trust (ILIT).  An ILIT provides a way to pass on wealth without incurring estate taxes, but also have great estate planning potential.  These are the reasons many Maryland trust attorneys love to use them in planning their clients’ estates.

An Irrevocable Life Insurance Trust, or ILIT, should be of interest to any person buying life insurance. The ILIT is not just for people with estate tax issues. The ILIT can allow you to control how and when insurance proceeds are distributed to beneficiaries. Rather than going straight to the beneficiary, the insurance company pays the proceeds into a trust that then pays the amounts to the beneficiary as quickly or as slowly as you decide. Such a trust can be particularly beneficial when the potential beneficiary is younger, may have potential marital issues, or has difficulty managing money.

The ILIT’s most popular feature is its ability to assist a person or family with estate tax issues. In addition to the federal estate tax, Maryland residents need to plan for the Maryland estate tax and Maryland inheritance tax, neither of which have the current large exclusion of the federal estate tax. Federal estate tax laws, while ever-changing, will likely never go away and you should assume you may be subject to the federal estate tax in the future. Nonetheless, the ILIT should remain a simple and effective estate tax planning tool, regardless of what future changes may be. While life insurance proceeds may not be subject to income tax, the estate tax may apply to life insurance policies owned at the time of death. Proper planning using an ILIT can eliminate an insurance policy from the person’s taxable estate. While professionals, such as good insurance agents, will know when a client should see an attorney to form an ILIT, it is worthwhile to have a basic understanding of the ILIT and how it works.


The IRS considers all property owned by a person at their death to be part of their taxable estate. Many do not realize their life insurance policy is an asset that’s part of their taxable estate, and, considering the real value of the death benefit is to anyone but the decedent, that view is understandable. However, federal tax law considers any policy “controlled” by the insured to have been owned by the insured at their death. If controlled, then the IRS will include the policy’s death benefit as part of the person’s estate. Therefore, if the IRS taxes the policy’s death benefit at an estate tax rate of 45%, the beneficiary of a $500,000 policy will only receive $225,000.

Additionally, an ILIT may also benefit a person with potential state tax issues. While the amount exempt from federal estate taxes has increased over time, your state’s estate tax rate may have remained the same. For instance, if your insurance policy causes your estate to be more than Maryland’s estate tax exemption, then the excess caused by the inclusion of the unprotected life insurance policy could be facing the 16% tax rate of the Maryland estate tax. If the person had established an ILIT, then there would have been no taxes due.

Implementing the Plan

When a person has potential estate tax issues, Maryland estate attorneys may suggest the person form an Irrevocable Life Insurance Trust. After the attorney drafts the trust documents, either a new insurance policy or an existing policy will be placed into the trust. If possible, the person would rather it if the trust purchases a new insurance policy. While transferring an existing policy may be the only option, the person must survive for three years before the policy will not be included in their estate and there could be gift tax issues if the transferred policy already has substantial value. The attorney will usually work with an insurance agent to choose the appropriate policy.

The person will need to fund the trust so it can purchase or make payments on the policy. To eliminate gift tax consequences, the person may prefer to transfer only amounts less than the annual gift tax exemption amount, which at this time is $14,000 per recipient. Since the trust can have multiple beneficiaries, the person may be able to give multiple gifts of the annual amount to fund the trust.

To qualify as an ILIT, the trust must be irrevocable and the founder cannot be the trustee. Therefore, the owner will not be able to reclaim the amounts contributed or the policy, and the owner will not be able to change the beneficiary of the policy or the beneficiaries of the trust. Further, the ILIT’s founder will not be able to borrow against the value of the policy.

Other Benefits

In addition, its ability to reduce estate taxes, the ILIT can provide other benefits as well. The ILIT’s life insurance policy will usually distribute its proceeds to the trust. The trust can then freely distribute the proceeds to the trust’s beneficiaries in accordance with the trust documents. The ILIT can, therefore, be used to quickly get cash to the person’s family if needed. Further, the trust can be drafted to delay the distribution.  For instance, the trust can withhold payment until a child attends college, reaches a designated age, completes a foreseeable bankruptcy or divorce, or any other concern you may have about a beneficiary has been resolved.  In contrast, an insurance company will immediately distribute life insurance proceeds, even if not in the best interests of the beneficiary.

Further, families with estate tax issues can direct the trust to use the funds to purchase assets from the estate. This will provide liquidity to the estate and may simplify the distribution of the assets of an otherwise illiquid estate. Since illiquid estates with estate tax issues will need cash to pay the estate taxes, the ILIT can both pay the estate taxes due while excluding its own assets from the estate.


While the ILIT has its burdens, the simplicity of the ILIT, its tax benefits, and its ability to provide specific manners to transfer assets will continue to make the ILIT a popular tool for estate planning. You should contact a Maryland estate planning attorney for more information on how to implement this valuable estate planning tool.

For additional information or to protect your life insurance through an ILIT, please contact Jeff Rogyom at (410) 929-4578.
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