facebook twitter instagram linkedin google youtube vimeo tumblr yelp rss email podcast phone blog external search brokercheck brokercheck Play Pause
Retired Military Finances 301: ILITs Thumbnail

Retired Military Finances 301: ILITs

Insurance Estate Planning

I often hear (normally from insurance agents) that life insurance is tax-free. That is only partially true. Life Insurance proceeds are not subject to income tax. They are however potentially subject to estate taxes. Now for the last 10 years or so, estate taxes haven't been an issue for most retired Senior Military Officers and NCOs. I'm not sure, but that could change with the current (2021) administration and Congress. While it is too early to take action, it isn't too early to learn about options to legally avoid estate taxes on life insurance proceeds.

Life Insurance and Estate Taxes

As I mentioned above Life Insurance proceeds from policies owned by the decedent are part of the decedent's taxable estate. If that estate exceeds the estate tax exemption, the portion that does exceed the exemption will be subject to estate tax. Currently the estate tax maxes out at 40% for estates that exceed the exemption by $1M or more.

It is worth noting that there is an unlimited marital exclusion so your spouse receive Life Insurance proceeds and other assets with no estate tax due regardless of the size of your estate. That won't be true when your spouse dies, so ultimately the life insurance proceeds still could be subject to estate tax.

If anyone other than your spouse is the beneficiary of your Life Insurance policy, the proceeds are part of your taxable estate.

Enter the ILIT

ILIT stands for Irrevocable Life Insurance Trust. Here is how it basically works:

  • You establish an ILIT with your estate planning attorney
  • You transfer money to purchase a life insurance policy or a life insurance policy to the ILIT. You can't undo this (hence the word irrevocable)
    • If the transfers are greater than the annual gift tax exclusion you'll need to file a gift tax return
      • If you transfer a Life Insurance policy, the cash value is the amount you use to determine if you exceed the annual exclusion
      • If you transfer cash, that is the value you use. In both cases, two spouses can contribute twice the annual exclusion
  • The ILIT is named as the beneficiary of your insurance policy
  • The trust document setting up the trust, specifies how the life insurance proceeds can be used
    • Surviving spouse can be beneficiary with other individuals named as beneficiaries after the surviving spouse passes
  • You continue to gift funds to the ILIT to pay the premiums going forward to keep the policy in force

It's Not that Simple Though

That is a very simple explanation. As with all things estate planning and tax planning related, the devil is in the detail. Here are some things you need to watch for

  • There is a 3-year look back (for all gifts). If you set up the ILIT within 3 years of your death, assuming the insurance policy is on you, the Life Insurance proceeds will be included in your taxable estate
  • You need to really give up control of the insurance policy (for instance, you can't change the beneficiary(ies))
  • Funding needs to be done very carefully

The best way to make sure you dot all the i's and cross all the t's is to work with a competent estate planning attorney.

Military Finances are Different

While this subject applies to all Americans, that isn't always the case. There are a lot of differences between financial issues facing active and retired military members and civilians. That's why we think you should work with a financial planner that deals with military and veteran finances each and every day. If you'd like to chat, give us a call or sign up for a free initial consultation.

If you found this article useful, you might like the following blog posts:

Inherit the Family Home? Tax Consequences for Military Officers


What Happens If a Military Officer Dies Without a Will


What Military Officers Need to Know About TSP and Estate Planning




Disclaimer
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by C.L. Sheldon & Company, LLC ), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. C.L. Sheldon & Company, LLC does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to C.L. Sheldon & Company, LLC website or incorporated herein, and C.L. Sheldon & Company, LLC takes no responsibility therefore. All such information is provided solely for convenience, educational, and informational purposes only and all users thereof should be guided accordingly. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from C.L. Sheldon & Company, LLC . To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. C.L. Sheldon & Company, LLC is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the C.L. Sheldon & Company, LLC ’s current written disclosure statement discussing our advisory services and fees is available for review upon request. DISCLAIMER OF TAX ADVICE: Any discussion contained herein cannot be considered to be tax advice. Actual tax advice would require a detailed and careful analysis of the facts and applicable law, which we expect would be time consuming and costly. We have not made and have not been asked to make that type of analysis in connection with any advice given in this blog post. As a result, we are required to advise you that any Federal tax advice rendered in this blog is not intended or written to be used and cannot be used for the purpose of avoiding penalties that may be imposed by the IRS. In the event you would like us to perform the type of analysis that is necessary for us to provide an opinion, that does not require the above disclaimer, as always, please feel free to contact us.