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A Quick Primer in ILITS: Irrevocable Life Insurance Trusts

Let's talk about life insurance and estate planning.

Life insurance is a way to ensure that your loved ones have assets and funds if you pass away. It's a great financial planning tool. But how does it play into estate planning?

For one, life insurance proceeds can provide your estate with some liquidity to pay your estate administration costs. These could include estate taxes, probate fees and liabilities of the estate.

This can be a huge benefit for those whose estates do not have ready and liquid funds to pay off their expenses.

But there's a potential problem with life insurance. Starting next year, the estate tax exemption might be at $1 million. Nobody knows for sure, since the law hasn't been amended to this extent yet. But if nothing happens in Congress, then the exemption amount will drop to the $1 million mark. This makes for many more taxable estates.

Here's another potential problem: Life insurance will be included in your gross estate if you owned it. This could easily make your estate go up in value and then be taxed, if the total value of your estate (plus life insurance) surpasses the estate tax threshold when you pass away.

Now, you might think that you can simply designate beneficiaries and solve the problem. But it's not that easy under the Internal Revenue Code.

If you have any incidents of ownership on that policy, then the policy will be added to the value of your estate, even if your beneficiaries get the ultimate payout. In that case, estate tax could cut into the payout that your beneficiaries get.

Incidents of ownership aren't as easy to figure out as you might think. This is a concept of tax law. As such, it's not that easy to argue your way out of it. Incidents of ownership could include the ability to change beneficiaries, or the ability to borrow from your policy.

How do you get around this? You can create an irrevocable life insurance trust, also known as an ILIT.

ILITs are some of the most complicated estate planning trusts, and an ILIT that's not correctly drafted could cost your estate. Have a look at the estate planning lawyers in our online directory if you want to discuss ILITs and life insurance.

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