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What's an Irrevocable Life Insurance Trust and Why Create One?

To understand what an irrevocable life insurance trust is and why it might benefit your estate plan, you need to know under what circumstances life insurance proceeds will be subject to federal estate and/or state death/inheritance tax.



Washington state imposes a death tax on gross estates exceeding $2.193 million. Washington adopted the Internal Revenue Code’s definition of gross estate. See RCW § 83.100.020(7). Internal Revenue Code § 2042(2) provides that a decedent’s gross estate includes “the value of all property to the extent of the amount receivable by all other beneficiaries as insurance under policies on the life of the decedent with respect to which the decedent possessed at his death any incidents of ownership…”


Incidents of Ownership.

Section 20.2042-1(c)(2) of the IRS Regulations provides that the term “incidents of ownership” is not limited in its meaning to ownership of the policy in the technical legal sense. Generally speaking, the term has reference to the right of the insured or his estate to the economic benefits of the policy. Thus, it includes the power to change the beneficiary, to surrender or cancel the policy, to assign the policy, to revoke an assignment, to pledge the policy for a loan, or to obtain from the insurer a loan against the surrender value of the policy.


ILIT to Sever Incidents of Ownership.

Individuals can potentially avoid this tax to the extent of life insurance proceeds through an irrevocable life insurance trust (“ILIT”) by effectively cutting off incidents of ownership that would otherwise cause the proceeds to be included in the decedent’s gross estate.

An ILIT must be carefully drafted so as to comply with applicable Internal Revenue Code regulations. For example, the decedent/insured must not have been the trustee of the trust or maintain any power to amend or revoke the trust. Be cognizant of the 3-year look back rule, estate calculation (does not apply if ILIT purchased policy directly).


Advantages of an ILIT include potentially passing life insurance proceeds tax free and/or providing liquidity for expenses associated with large estates. An ILIT can provide shelter from the surviving spouse’s creditors or creditors of other beneficiaries. One disadvantage is the lack of control over the policy which may prove costly if life circumstances change. Care should be taken to ensure an ILIT makes sense to achieve your estate planning objectives.




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