What is the Difference Between a Revocable and an Irrevocable Trust?
There are several different types of trusts available for those with estate planning goals in the state of California. What kind of trust suits you and your needs will depend on various circumstances and may be determined on a case-by-case basis. However, before proceeding any further and discussing irrevocable life insurance trusts, we must first understand the difference between a revocable and an irrevocable trust.
Irrevocable trusts cannot be easily modified or terminated, at least not without the express permission of every beneficiary. Once the irrevocable trust has been created and implemented, it is unchangeable. The inability to change the language and terms of the trust gives the irrevocable trust its strengths and benefits period; namely, an irrevocable trust provides a certain level of asset protection to trust creators and beneficiaries. As the estate assets in the irrevocable trust are no longer considered your property, they are generally shielded from lawsuits and creditors. Also, trust assets in irrevocable trusts are usually not included in your taxable estates, potentially saving you a lot of money in estate taxes.
On the other hand, a revocable trust is very flexible and easy to update or edit, often called a living trust; the irrevocable trust allows its creator to modify the document’s terms, add or remove trust assets, and even terminate the trust at any given time. This added flexibility benefits those whose financial or family circumstances may change. However, unlike an irrevocable trust, estate assets in a revocable trust remain part of the creator’s estate for tax and asset protection purposes. Both types of trusts help surviving loved ones avoid the expensive probate process and allow for a smoother transfer of assets after the trust creator’s death.
What is a California Irrevocable Life Insurance Trust (ILIT)?
Those looking to address inheritance and estate taxes and reduce the possibility of probate litigation or lawsuits endangering estate assets may consider an irrevocable life insurance trust (ILIT). The estate assets within the ILIT can be one or more life insurance policies. Keep in mind, however, that as the ILIT is irrevocable, it cannot be easily modified, rescinded, or amended once it is created.
An irrevocable life insurance trust is only one legal option for transferring wealth to surviving family members and loved ones. When you purchase a life insurance policy, you can transfer that policy into the trust to ensure that your loved ones will have financial security today and into the future.
Some individuals must open an irrevocable life insurance trust based on their unique circumstances. When people own estates and valuable assets, their estates are taxed after passing. However, suppose you transfer your life insurance policy into a trust. In that case, it will no longer be included as part of your estate, meaning that tax laws will not apply to them similarly.
Three primary types of life insurance can be used in an ILIT: universal life insurance, term life insurance, and whole life insurance.
What Are the Benefits of Irrevocable Life Insurance Trusts?
Using an ILIT as part of your estate planning can yield several unique benefits to you and your loved ones.
The benefits of ILITs include the following:
- The primary advantage of an irrevocable life insurance trust is that it keeps insurance proceeds out of your taxable estate. The estate tax reduction is beneficial for married couples as it provides a means for both spouses to defend themselves from estate taxes and look for exemptions
- Suppose you gift money or assets to the irrevocable life insurance trust to pay for insurance premiums. In that case, you can take advantage of annual gift tax exclusions. This estate planning strategy can help further reduce the size of your taxable estate and save you and your loved one’s money
- Assets within an ILIT are usually protected from creditor claims, lawsuits, and bankruptcy filings
- Because the trust owns the life insurance policy now, any cash value and death benefits are typically prevented in the event of a divorce from your spouse
- Assets within an irrevocable life insurance trust bypass the California probate process, allowing for a smoother transfer of assets to named beneficiaries
- If you include special needs provisions and planning in your ILIT, it can help your beneficiaries remain eligible for means-tested government aid programs
Are There Drawbacks to Creating an ILIT?
While creating an ILIT has several significant benefits, the estate planning tool has drawbacks that you must remember.
Potential downsides of an irrevocable life insurance trust include the following:
- Once you transfer your life insurance policy into the trust, you lose control over that policy. If your situation changes or you need to change beneficiaries, this could present a problem
- It is impossible to make changes to the trust document without the approval of your designated beneficiaries
- When you fund an irrevocable life insurance trust, you do so by making yearly gifts. However, you may need to pay a tax on your gifts, significantly if your gifting exceeds the gift tax exclusion limits
- You are no longer allowed to use the cash value of your life insurance policy after moving that policy into the trust
How to Structure an Irrevocable Life Insurance Trust in California?
The structure of an irrevocable life insurance trust is based on three key roles: the grantor (the creator of the trust), the trustee, and the named beneficiaries.
The insured is generally the individual who establishes the irrevocable life insurance trust. Once the trust has been established, they will henceforth be referred to as the trustor, said Lord, or grantor.
The trustee is the individual or entity designated with the trust administration. They have the fiduciary duty to pay insurance premiums, collect death benefit proceeds when the insured individual dies, and distribute those proceeds to the designated beneficiaries following the language of the trust document.
Beneficiaries are the individuals or entities who ultimately receive the benefits according to the terms of the ILIT. The beneficiary may benefit from the trust during the trust creator’s lifetime, such as whenever a gift is made to the trust. Also, the beneficiary will benefit from the trust after the grantor’s death.
Schedule Your Free Consultation with Our California Legal Team Today
An irrevocable life insurance trust is an advanced estate planning measure available to individuals concerned about estate taxes, potential lawsuits or creditor claims, and other legal concerns. While not everyone would benefit the same from creating a life insurance trust, those who would stand to make things easier for themselves and their loved ones both during their lifetimes and after their passing.
Our California law firm has extensive experience assisting clients with various types of estate planning measures, and we would be proud to represent your interests throughout the legal process.
To learn more about our legal services, don’t hesitate to get in touch with our Los Angeles law office to schedule a free case evaluation with our legal team today. You can reach us at 818-658-2174.
