Irrevocable life insurance trusts sound scary and a little confusing at first. The reality is that this type of trust is a useful tool that can help beneficiaries avoid estate taxes.
This estate planning tool isn’t for everybody, though. Specifically, irrevocable life insurance trusts are designed for people who have a high net worth or multiple assets.
How irrevocable life insurance trusts protect against estate taxes
Estate taxes are assessed when a beneficiary inherits a life insurance policy or any assets that were passed down after someone’s death. This tax is collected against the fair market value of the assets at the time they are transferred since it’s considered another form of earned income.
For people with highly valued assets and a large net worth, this could mean that the actual amount their beneficiaries inherit may be greatly reduced. An irrevocable life insurance trust may exclude certain life insurance policies from estate tax.
Irrevocable life insurance trusts act as both owner and beneficiary, a middleman between the death of its owner and the intended beneficiaries. Within the trust, intended beneficiaries are included in the plan and still have access to the insurance policy.
Are there any downsides?
There are a few. You cannot make any changes after setting up an irrevocable life insurance trust. If something happens (such as a new marriage, new beneficiary, loss of income, et cetera), then the trust cannot be changed.
It costs a lot upfront to set up an irrevocable life insurance trust as they are complex. While it does offer plenty of tax-saving benefits for beneficiaries, a lot of care and consideration should be taken when making an irrevocable life insurance trust.