Most people purchase life insurance to ensure their loved ones will be financially sound upon their demise. While the details of these policies vary, they generally fall into one of two categories—whole life or term. A whole life policy provides permanent coverage and has a cash value that can be “surrendered” (withdrawn) during the insured’s lifetime. A term policy has no cash value during life, may expire without paying any benefits, and pays out only upon the death of the insured. Life insurance is taxable in the decedent’s estate, and thus, a large policy can trigger unplanned estate tax ramifications.

Enter the Irrevocable Life Insurance Trust (ILIT), designed specifically to hold your life insurance policy. The ILIT is an effective tool that allows you to maintain your life insurance policy while ensuring the proceeds are not subject to estate tax. It works as follows: You are the creator of the ILIT and you designate other individuals (or an entity) as Trustee(s). You then purchase a policy in the name of the ILIT (the ILIT is the owner), but you remain the insured. The beneficiaries of the policy are those designated by you within the ILIT. Upon your passing, the value of the policy is removed from your taxable estate. Alternatively, if you have an existing policy, it can be retitled to an ILIT—if you survive three years from the date of transfer, the proceeds will not be includible within your taxable estate, and consequently, not subject to estate tax.