Trusts for physicians part 5: Life insurance trusts

Affluent physicians can effectively use trusts to manage large life insurance policies. In part 5 our ongoing look at the use of trusts as asset protection and estate planning tools, we examine the use of Irrevocable Life Insurance Trusts or ILITs.

We started this series with the basic vocabulary of trusts that every doctor should know, followed by a look how trusts are taxed and some of the abusive trust-based tax planning targeting doctors you must be aware of before filing your taxes next month. Most recently, we took our first look a specific estate planning trust that is the most widely applicable to physicians, the revocable living trust. Today we look at another specific, special purpose trust, the ILIT.

What is an ILIT?

An ILIT is an irrevocable trust that is created to own term and whole life insurance policies as well as cash and various other valuable assets that may be used to fund policy premiums or managed for the benefit of the named beneficiaries.

The policy may be purchased by the ILIT as the “policy owner” at its original issuance or later sold or gifted to the trust by the Grantor. The Grantor appoints a Trustee who can make required and/or discretionary distributions and who helps manage the trust. For maximum asset protection for all parties, it is best to use a third-party trustee who is neither a grantor nor a beneficiary as the trustee.

What does an ILIT do?

ILITs are most commonly used to put the proceeds of a large life insurance policy outside the taxable estate of the grantor and their beneficiary spouse. This allows the death benefit to be used to supplement the value of the estate and the income available to the surviving spouse and heirs and to help pay any estate taxes that might be due by purchasing illiquid assets that might otherwise have to be sold to pay the taxes, as just one of several examples.

Why shouldn’t a grantor or beneficiary also be a trustee?

We do not want a Grantor to retain control of what is supposed to be a completed gift to the trust as Trustee. Nor should we use a Beneficiary, who has the power to make discretionary distributions of trust assets as Trustee, and who could be forced to make a distribution to his or her own creditors. Both scenarios allow for possible creditor access.

The ILIT provides creditor and principal protection of the assets in the trust (including any death benefit received upon the death of the insured) in several ways:

1. To protect the assets in the trust from estate tax by excluding them from the grantor and their spouse’s taxable estate.
2. To protect the cash value and death benefit of a life insurance policy from creditors. Creditor protection laws on the death benefit and cash value of life polices varies widely by state and may not be equal for both categories. For example, Arizona law protects the cash value of qualified life insurance policies to an ‘unlimited’ dollar amount, but only $20K of the death benefit, (which could be millions), is protected from the creditors of the beneficiaries themselves, including future spouses. As such, if the beneficiaries of your estate face a future lawsuit, bankruptcy, or divorce this asset can be protected from those exposures or even from the beneficiary themselves if they are minors or have other significant exposures like mental or physical disabilities, addiction problems, or other behavioral issues.
3. It protects present assets intended to go to the beneficiaries, including cash or other liquid equivalents you may intend to fund the policy with now or in the future, from the Grantor’s own creditors. It does this by making an irrevocable present transfer of exposed assets into a “safe” that the trustee can use to pay for the insurance premiums in the future.

Examples of who may need an ILIT

• For legal gift, GST and estate tax avoidance by those who have a current or pending estate tax exposure (net worth currently over $12.1MM for an individual or $24.2MM for a married couple, exempt amount should decrease in 2026).
• Those who want asset protection for the cash value and death benefit of the polices
• Those who want the trustee to control distributions for vulnerable beneficiaries of those who cannot take outright distributions and still qualify for specific government benefits

Ike Devji, JD, has practiced law exclusively in the areas of asset protection, risk management and wealth preservation for the last 16 years. He helps protect a national client base with more than $5 billion in personal assets, including several thousand physicians. He is a contributing author to multiple books for physicians and a frequent medical conference speaker and CME presenter.