How Does an Irrevocable Life Insurance Trust (“ILIT”) Reduce Your Estate Taxes?

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Do you have life insurance? You may be surprised to learn that the payout on your life insurance may be subject to tax. Massachusetts residents with more than $1,000,000 at the time of death may be required to pay estate tax. The good news is that an Irrevocable Life Insurance Trust can reduce your estate tax liability dramatically by removing your life insurance from your taxable estate.

Life insurance is an important part of estate planning, especially for parents with young children. It allows your family to maintain the same quality of life in the event of your untimely death. Life insurance can cover funeral costs, child-care, or college tuition, as well as day to day living expenses. Given the numerous uses, life insurance proceeds can be quite large and often comprise the majority of a person’s estate after they die.

Will You Have to Pay Estate Taxes?

If you are a Massachusetts resident with more than $1,000,000 in assets at the time of your death, you may be subject to Massachusetts estate tax. Because the federal estate tax exemption is currently over $12,000,000, it is unlikely that you will need to pay tax to the federal government. The Massachusetts estate tax, however, will apply to many Mass. residents, particularly those who have life insurance policies.

Life Insurance is Included in Your Taxable Estate

When the IRS and Department of Revenue add up the value of your estate, they will include everything you own at the time of your death. This includes your bank accounts, real estate, retirement accounts, digital currency, life insurance proceeds, and more. If you own any assets jointly, they will only count half the value of that asset. If you live in Massachusetts and you own real estate in another state, the Massachusetts Department of Revenue will not include the value of that real estate when calculating the total value of your taxable estate.

How can I pass my life insurance policy to my family tax-free?

You can take the value of your life insurance policy completely out of your taxable estate, and therefore reduce or eliminate your estate taxes, by creating an Irrevocable Life Insurance Trust, also known as an ILIT.

There are special rules that must be followed in order for the ILIT to be effective, so it is important to work with a professional when setting up an ILIT.

For instance, the trust must purchase your life insurance policy. As the insured, you relinquish control to the ILIT. At the time of the creation, however, you can determine how you would like the assets distributed upon your death (i.e. are the proceeds distributed immediately, or based on the ages of beneficiaries).

When is the Right Time to Get an ILIT?

Ideally, create the ILIT before obtaining life insurance and have the trust apply for a life insurance policy on your behalf. If you already have life insurance, don’t worry. You can still implement an ILIT strategy. But there is a three-year waiting period before the life insurance is removed from your taxable estate.

Considering an ILIT?

Estate planning can feel overwhelming. ILITs are confusing and require thoughtful planning.

Bedford Family Lawyer is here to help. We are a full-service estate planning firm and can walk you through the process one step at a time. Click here to learn more about our flat-rate fees, or book a consultation.

Rebecca Neale

Principal Attorney

As an attorney, Rebecca represents people in divorce, custody, and guardianship proceedings. She also advises people about end-of-life decisions and creates estate plans tailored to their needs and goals. Read more about Rebecca’s Experience here.
Bedford Family Law

Bedford, Massachusetts

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