In the world of estate planning, staying ahead of legislative changes is crucial, especially in anticipation of the upcoming 2025 estate tax exemption sunset. Financial advisors and estate planning attorneys working to ensure that their client’s assets are protected and passed on efficiently to loved ones are challenged with how to best adapt to this potential change come January.
2025 Estate Tax Exemption Sunset:
As it stands, the current generous estate tax exemption of $13.6 million per individual and $27 million for married couples, is set to expire, potentially reverting to its pre-2018 amount, which should be around $6.8 million per individual and over $13 million for a couple. Additionally, the 40% maximum gift and estate tax rate is due to increase to 45% in 2026. This alteration could have far-reaching implications for an estimated 1.3 million households and their estate planning strategies.
Should the estate tax exemption decrease, more estates could be subject to taxation, necessitating proactive measures to minimize tax liabilities and preserve wealth for future generations. Consequently, financial advisors and estate planning attorneys must prepare their clients for potential shifts in tax laws and adjust their strategies accordingly to navigate the evolving landscape effectively.
Benefits of Using an Irrevocable Life Insurance Trust:
For affluent clients, an Irrevocable Life Insurance Trust (ILIT) can offer a strategic solution to navigate the uncertainty surrounding the upcoming estate tax exemption sunset. By establishing an ILIT, clients can ensure several key benefits, even in the face of changing tax laws.
One of the greatest benefits of an ILIT is that it keeps your client’s life insurance policy(ies) outside of their taxable estate, effectively minimizing the impact of estate taxes on the policy’s proceeds. This arrangement allows beneficiaries to receive the death benefit, preserving wealth for future generations.
Because beneficiaries receive the death benefit, ILITs also provide the benefit of liquidity. While assets such as real estate or small businesses are non-liquid, a death benefit is a liquid asset that beneficiaries can use to help them pay the “death tax,” or estate and inheritance taxes.
Once an ILIT is established, clients can transfer cash, securities, or other assets to the trust as gifts, where they can grow without being subject to estate taxes and ultimately pass on to beneficiaries free of the federal estate tax.
One final benefit to an Irrevocable Life Insurance Trust is that, if properly structured, the trustees have control over the distribution to the trust’s beneficiaries, which can be useful in cases where the beneficiaries are very young or have special needs.
Read More: 5 Advantages of ILITs for Estate Planning
Potential Drawbacks of Using an Irrevocable Life Insurance Trust:
Although ILITs can be an excellent estate planning tool for some of your clients, they do come with a lack of flexibility that may not align with every client’s preferences or needs. One consideration is your client’s net worth. Because ILITs are irrevocable, any assets placed in the trust can no longer be accessed by the grantor, even if financial circumstances change. For example, a client with a net worth of over $25 million likely has enough assets outside of the trust to continue supporting their lifestyle, however, a client with a net worth of $15 million may still want to have access to their assets.
Practitioners should also be mindful of any potential look-back periods when transferring an existing policy into an ILIT. Transferred policies must be held in the trust for at least three years to remove the death benefit from the estate. This time frame necessitates careful planning and foresight. Your client can instead gift a new policy within the ILIT, in which case the three-year rule will not apply, and the death benefit will be removed from the grantor of the trust’s estate immediately.
Perhaps the largest drawback many financial advisors and estate planning attorneys find with irrevocable life insurance trusts is the complexity of their administration. If not properly maintained and managed, an ILIT is unlikely to deliver the results that your client and their beneficiaries would expect.
Read More: The Many Duties and Responsibilities of an ILIT Trustee
In summary, the impending changes to the estate tax exemption in 2025 necessitate proactive estate planning strategies for high-net-worth individuals. While ILITs offer compelling benefits such as estate tax minimization and wealth preservation, they also come with specific limitations that must be carefully considered.
Read More: Is an ILIT Right for Your Client’s Estate Plan?
If you are contemplating the use of an ILIT for any of your client’s estates in light of the 2025 estate tax exemption sunset, but are hesitant due to the complexities of life insurance trust management, consider partnering with Life Insurance Trust Company (LITCO). As an industry leader in irrevocable life insurance trust services, LITCO specializes in supporting multi-generational legacies. Our team of experts collaborates with grantors, financial advisors, and attorneys to maximize results and protect assets within the trust. Request a consultation to learn more about partnering with LITCO for successor trustee services and safeguarding your client’s wealth for generations to come.
