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When Estate Planning and Divorce Intersect

Posted in Divorce and Money

Irrevocable Life Insurance Trust

An irrevocable life insurance trust is a trust specifically designed to remove the death benefit of life insurance from your gross estate (the total dollar value of all property and assets at the time of your death).

Most people fail to realize that when you own a life insurance policy, it tends to increase your gross estate at the time of your death. For instance, let’s say you pay $20,000 into a life insurance policy over the course of your life and then you pass away. The death benefit is $100,000 and the entire $100,000 is considered part of your gross estate, not just the $20,000. So, in order to get that death benefit out of your gross estate and reduce your overall estate tax, people put life insurance inside an irrevocable life insurance trust (ILIT).

In contrast, a revocable trust is something that the IRS considers to be part of your gross estate; the grantor (the trust creator whose assets are put into the trust) is entirely responsible for any taxes that the investments inside the trust generate.
In further comparison, with an irrevocable trust, the trustee (the managing party administering the assets for the benefit of a third party) is responsible for paying the taxes at the trust tax rate. Whereas, with a Revocable Trust the grantor is responsible for the taxes, at the grantor’s tax rate.

Something to keep in mind: Both Irrevocable Trust and Revocable trusts reach the highest tax rate more rapidly than an individual taxpayer. There are no Estate Tax, or Income Tax benefits to a revocable trust.

Some benefits of having an irrevocable life insurance trust:

  • Provides liquidity for the family or beneficiary to pay the Federal Estate Tax
  • Removes the total death benefit from the gross estate of the grantor(s)
  • Helps to reduce estate taxes
  • Has its own Tax I.D. Number
  • Does not have to go through probate, remaining private and out of the public eye.


Sometime ago, I was brought into a divorce case where a couple with children had set up an irrevocable life insurance trust. Every subsequent year they would gift money into the trust, as the grantors, to fund the life insurance policy on the husband and wife. Normally a trustee will send out Crummey letters – letters notifying the beneficiaries that they have the right to withdraw the grantor’s gift. If the beneficiaries decide not to do anything after 30 days, the trustee is obligated to put the gift into the life insurance policy; that becomes the annual premium for the life insurance policy. The purpose of the Crummey letters are to make the grantors gift, a gift of a present interest. The beneficiaries may decide to use or spend said gift immediately – they don’t have to wait for some future date to enjoy the gift.

This trust was written with certain parameters allowing the trustee to withdraw money; emergencies, failing health, medical expenses, education or his/her well being. If at any time the trustee pulls money out as the grantor, that would make the trust revocable, losing all preferential tax treatment.

Irrevocable trusts are also generally designed to go to the children when both parents are no longer alive. That way the children have liquidity to pay Federal Estate Taxes, which are due nine months after the date of death of the second spouse.

Well, this family was now going through a divorce and the issue was that one spouse was the sole trustee. The other spouse wanted to keep the irrevocable trust in place for the kids but wanted to make sure that the ex-spouse would have no access to it — no matter what.

Would the attorneys have to break the trust, collapse the life insurance policy and begin again? Their task was to make sure the kids still get the benefit of the original trust – all while terminating any rights of the ex-spouse over the trust.

Because of my experience in Estate Planning, I was able to look over the trust and determine that it was feasible that the ex-spouse resign as trustee and designate a successor trustee. In a situation like that, both parties would need to approve the successor trustee. We incorporated that change into the divorce decree, keeping the trust intact and insurance in force.

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