In order for life insurance to do what it’s supposed to — pay out a death benefit to your loved ones— you need to designate beneficiaries in your policy. Your beneficiaries are the people who will receive the death benefit if you die.

But for people with a high enough net worth, the life insurance death benefit may be subject to estate taxes when they die. To protect the funds from high taxes, you can put your life insurance policy into an irrevocable life insurance trust, or ILIT. When your policy is held in an irrevocable life insurance trust, the trust is the policyholder and the beneficiary. Because you aren’t the policyholder, it won’t be subject to estate taxes to increase your taxable estate to the point that your estate’s value will exceed the exemption limits.

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You may want to put your life insurance policy in an irrevocable life insurance trust if your intended beneficiary is a minor, in which case the court won’t pay out the death benefit until they turn 18. 

Read on to learn more about when to put your life insurance in a trust, how it works and who needs it.

What is an irrevocable life insurance trust?

Trusts hold assets such as money and real estate. An irrevocable life insurance trust holds your life insurance policy. The ILIT would be the policyholder, not you.

Because you aren’t the policyholder, the life insurance money is not a part of your estate, and will not be subject to the same estate taxes as the rest of your estate. Additionally, it can’t be dispersed alongside the rest of your estate — only your listed heirs will get the death benefit.

An irrevocable life insurance trust is, well, irrevocable. The designations you make for the trust can’t be changed at a later date. 

How does an irrevocable life insurance trust work?

After setting up an irrevocable life insurance trust, you will transfer your life insurance policy to the trust. It will pay the premiums, though they will still be funded by you. The trust is also the beneficiary and will receive the death benefit when you die.

The family members you designate as your trust beneficiaries will then receive the money from the trust.

Keep in mind that when you fund a trust to make the premium payments, the IRS charges a gift tax. You can shield up to $15,000 from the gift tax by exercising something called Crummey powers on your trust, which enables you to give a tax-free gift.

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How to set up an irrevocable life insurance trust

Setting up an ILIT can be very complicated, and you should consult with an estate planning attorney to make sure you aren’t subject to any negative tax consequences.

To set up an irrevocable life insurance trust and use it with your life insurance policy, you will need to:

• Open the trust and deposit money to pay for the life insurance premiums
• Select the people listed in the trust
• Transfer your life insurance policy into the trust

An estate planning attorney can guide you throughout this process. 

Who is listed in an irrevocable life insurance trust? 

In general, the trust will have three main people listed. You’ll want to get these right, because it determines how the life insurance funds are paid out. These cannot be changed later. 

The beneficiaries: The people who receive the money from the trust.

The trustee: The person who administers the trust.

The grantor: This is the person who would be considered the insured on the life insurance policy. When they die, the trust pays out to the beneficiaries. 

Who needs to put their life insurance policy in a trust?

Generally, irrevocable life insurance trusts are for people who have a high net-worth estate. 

If your estate exceeds the federal estate tax limit of $12.92 million, or a life insurance policy would push it over that limit, you may need an ILIT. An irrevocable life insurance trust would lower your taxable estate. Even if your estate is already over the federal estate tax limit, putting a policy in an irrevocable life insurance trust would ensure that it’s not liable to estate taxes. 

“Not only does the ILIT shield the policy from the demands of creditors, spouses, and other interested parties, it is also outside of the insured’s gross estate, and consequently avoids estate taxation by the IRS,” says Steve Parrish, adjunct professor of advanced planning at The American College of Financial Services

Additionally, if you would like to leave the death benefit to minor children, an ILIT is a good option. Life insurance companies won’t pay out the death benefit to children under the age of 18, which means they may not receive the funds when they really need it. You can list the beneficiary of an ILIT in the interest of your children so it can be used toward their care. Again, you’ll want to speak to an estate planning attorney to ensure you’re listing the right beneficiaries on the trust so that the death benefit can be used the way you intend it to. 

People who don’t have complex financial needs or plan to leave the death benefit to an adult typically don’t need the complexity of an irrevocable life insurance trust. You can leave behind written instructions, such as a will, so that your beneficiaries know how you’d like the death benefit to be used.