A life insurance trust (ILIT) protects your life insurance from estate taxes. ILITs work because you no longer own the life insurance policy. Instead, it’s owned by the trust. So when you die, the trust gets paid but that has nothing to do with your estate, even though the payment was triggered by your death.
IRS has come up with many requirements for considering a life insurance trust valid. Some of those requirements are highly technical. Many of the requirements have to do with the fact that you have to give up all traces of ownership of the life insurance policy – you have to give it up to the trust in the most legally complete way.
Nevertheless, as long as the legal and tax requirements are met, life insurance trusts are flexible and customizable, allowing you to address life situations such as remarriage of a spouse and death of other beneficiaries. Some life insurance trusts also allow the spouse to determine what happens to money in the trust after their death (this is called the power of appointment). You can have a relative, friend, or a professional be the trustee who manages the trust.
You can be very flexible in establishing the trust, spelling out your wishes as to what happens to the life insurance proceeds after your death, all without having the beneficiaries pay estate taxes. A life insurance trust is a great tool in estate tax planning.