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An irrevocable life insurance trust is a type of trust set up to hold a life insurance policy rather than the usual trust for money and property. In such a situation, the trust owns the life insurance policy instead of the person who purchased the policy and created the trust. Since this type of trust is irrevocable, no one can change or cancel it after it is created. Likewise, the grantor cannot take the life insurance policy back.
Often, people set up irrevocable life insurance trusts to keep insurance policy proceeds from being subject to estate taxes after they die. Normal life insurance policies are typically subject to these taxes. If a person transfers his life insurance policy to a trust, his beneficiaries can benefit from the proceeds without losing considerable sums to estate taxes.
In some types of trusts, the grantor of the trust can also serve a trustee. This is not the case with an irrevocable life insurance trust. If the grantor of a trust also serves as a trustee, he may be seen as having ownership in the trust, which wouldn’t protect it from estate taxes. The grantor may choose any other person to serve as a trustee, including his spouse or offspring.
There are some potential disadvantages to consider when creating an irrevocable life insurance trust. One of them involves the life insurance policy’s beneficiary. The trust becomes the beneficiary of the policy, and the grantor loses the right to change that designation. He can set the beneficiaries of the trust, but if his family situation changes, he doesn’t have the flexibility to makes changes that most people have with life insurance policies.
Another potential disadvantage is that the grantor can’t borrow against the life insurance policy once the trust is created. Some people like to have this option available to them in case difficult circumstances arise. If the grantor were allowed to borrow against the policy placed in the irrevocable life insurance trust, he would be considered the policy’s owner, which would make the policy’s proceeds subject to estate taxes.
Some people may also see this trust’s irrevocability as a major disadvantage. The grantor cannot take the life insurance policy back once the trust is formed. In the event that he becomes uninsurable, the life insurance trust may be his only insurance policy. If his life insurance needs change after the trust’s creation, the irrevocability could be a problem.