Proposed New Tax Bill Impact on Life Insurance Trusts

One of the most common tools in the estate planner’s toolbox is an Irrevocable Life Insurance Trust, or ILIT for short. The ILIT is useful for clients who have a life insurance policy that, if included with their other assets, would be subject to the estate tax.

Consider this example: a client is a single mom and has five children. She buys a twenty-year term life insurance policy with a $5 million dollar payout so that if she dies within twenty years her children will receive the proceeds.

The problem: although the current estate tax exclusion amount is $11.7 million, that is set to suddenly reduce to around $6.2 million (inflation adjusted) on January 1, 2026. (ALERT: new tax law proposals could reduce the estate tax exclusion to $6.2 million on January 1, 2022.) So, if the woman died with the $5 million dollar policy in her estate, and if she owned more than $1.2 million in other assets, her estate will be subject to taxation because her taxable estate would be over the estate tax exclusion amount.

The fix: this is where the ILIT comes into play. Estate planners create an irrevocable trust that would own the life insurance policy. Because the woman did not own the policy when she died, it would not be included in her estate – and therefore her estate would not be subject to taxation.

The new problem: there are proposed changes to the tax laws that would make traditional ILIT planning more difficult, because new gifts to the ILIT to pay premiums would be disallowed. Traditionally, our client could gift funds to the trust to pay for premiums and the ILIT would allow income from those gifts to be used to pay for the premiums. That arrangement will no longer be allowed on an ongoing basis and doing so would counteract the planning and require the policy to be included within the client’s estate making the taxable estate larger and exposing it potentially to more estate tax.

The new fix: as with many things, time is of the essence. The laws have not yet been put in place, but potential changes would apply to ILITs settled after the enactment of the legislation as opposed to after the end of the year. One thing our client could do is set up a separate bank account in the name of the ILIT and fund it with enough money to cover future premium payments. This is just one possible solution, and can be done without payment of any gift tax as long as there is available estate tax exclusion to cover the funding.

If you have an ILIT, Strauss Attorneys stands ready to help you review the terms of the trust and go over options with you.