I'm Embarrassed to Ask: What Is a Life Insurance Trust?

An older man has his hand on the side of his face and head tilted like he's embarrassed to be asking.

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Editor's note: This is the first article in a series about financial and/or estate planning issues that we all should know but might be too embarrassed to ask about. First up: life insurance trusts.

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But as the years have gone on, and more baseball data points get thrown around with new names, I often find myself nodding along without really knowing what all of the new sabermetrics mean.

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Many of us hit a point in our lives when we've heard about topics and phrases so many times that we believe we should understand what they mean, but we don't — and we're a little embarrassed.

Kiplinger's Adviser Intel, formerly known as Building Wealth, is a curated network of trusted financial professionals who share expert insights on wealth building and preservation. Contributors, including fiduciary financial planners, wealth managers, CEOs and attorneys, provide actionable advice about retirement planning, estate planning, tax strategies and more. Experts are invited to contribute and do not pay to be included, so you can trust their advice is honest and valuable.

This series of articles is meant to help you answer some of the many financial and/or estate planning questions that you have been too uncomfortable to ask.

The first one is a doozy: life insurance trusts.

The reason people don't ask about life insurance trusts is that the topic itself can seem daunting and can lead to three grim prospects:

It's boring
It's complicated
It includes talking about dying

In this article, I'll walk you through what you need to know to determine whether you really need a life insurance trust.

First, let's refresh our baseline knowledge of irrevocable trusts.

Irrevocable trusts: The basics

A lifetime irrevocable trust is a trust that you establish during your life, and where you forfeit control over the assets inside. There are three key benefits to using an irrevocable trust as part of an estate plan:

You minimize future estate taxes by reducing your current estate value and removing future appreciation
You protect your heirs' inheritance from creditors
You control when and how heirs receive their inheritance

Irrevocable life insurance trusts

Now, add in the concept of funding this trust with life insurance. An irrevocable life insurance trust (ILIT) is a trust established during your life where the trust either owns a life insurance policy on your life (the grantor) or is named as the life insurance beneficiary. In either case, the policy pays out to the trust upon death.

But why should life insurance be part of your estate plan?

Life insurance can play an important role in estate planning, fulfilling a multitude of roles, including but not limited to protecting your dependents from lost income, covering your debts and expenses after you die, creating an inheritance, or providing liquidity for estate taxes due upon death.

For those individuals looking to create an inheritance, it may be more appealing for the insurance to pay into a trust rather than directly to the beneficiary. This allows the grantor to us the hallmark benefits of a trust, as explained above.

To get these specific benefits, the life insurance policy only needs to name a trust as a beneficiary. An important point to remember here is that the trust must be established first before it is named as the beneficiary on your life insurance policy.

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However, for individuals or couples whose net worth is nearing or above the federal estate tax exemption ($15 million/taxpayer and $30 million/married couple in 2026, indexed for inflation), and who are using life insurance to either create an inheritance or offset estate taxes due, then having the trust own the life insurance policy should be considered.

Why? If you have life insurance directly at the time of your death, the entire death benefit payout will be added to your estate, which can potentially create or compound a federal estate tax bill.

If you use an ILIT to own the life insurance policy, you have transferred the value of the policy out of your estate.

For those of you living in states that still have their own estate or inheritance taxes, this could be a powerful tool to minimize that burden.

Life insurance trusts: Key takeaways

Whether you need an ILIT as part of your estate plan is largely determined by your net worth and where you live.

If you believe that a life insurance trust should be part of your estate plan, it's important to work with an experienced attorney and financial planner to guide you on the nuances of this strategy.

This article is for general information only and is not intended as an offer or solicitation for the sale of any financial product, service or other professional advice. Wilmington Trust does not provide tax, legal or accounting advice. Professional advice always requires consideration of individual circumstances.

Wilmington Trust is not responsible for any errors or omissions contained in this article.

All information is provided "as is," with no guarantee of completeness, accuracy, or timeliness, and without warranty of any kind, express or implied.

Wilmington Trust is not liable to you or anyone else for any decision made or action taken in reliance on any information in this article. Opinions are subject to change without notice.

Wilmington Trust is a registered service mark used in connection with various fiduciary and non-fiduciary services offered by certain subsidiaries of M&T Bank Corp.

Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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Marguerite is the Chief Operating Officer of Wilmington Trust Emerald Family Office & Advisory®, where she leads a platform of strategic advisory services tailored for executives, entrepreneurs and their families. As National Director of Family Legacy Strategies, she oversees a national team of wealth planners, accountants and legacy advisers, delivering personalized estate, succession and legacy planning solutions to high-net-worth clients.