Under the Tax Cuts and Jobs Act of 2017, the federal estate tax exemption increased from $5.49 million to $11.4 million per individual (in 2019). This boost means a married couple can exclude a staggering $22.8 million from estate tax!

But this dramatic change has also prompted many clients to question whether they still need an irrevocable life insurance trust (ILIT) if their estate is valued below this exemption. The answer is . . . it depends. Here, we’ll examine the factors that may determine if clients still need an ILIT, and we’ll also dive into the questions you should be asking to help your clients make the choice that best aligns with their estate planning goals.

What Tips the Scale

To help your clients assess whether they still need an ILIT, start with the primary factors.

Legislation. It’s important to keep in mind that the federal estate tax exemptions are not permanent. Unless the laws are changed, beginning in 2026, the estate tax exemptions will sunset and revert to the amounts in place prior to the Tax Cuts and Jobs Act. So, if your client previously had an estate tax need for an ILIT, that need could return as early as 2026. The lingering question, of course, is what will occur with estate tax legislation in 2026 and beyond.

State estate tax. Some states have a separate state estate tax, meaning a tax may be due depending on the size of the estate. This tax applies to clients living in Connecticut, the District of Columbia, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, and Washington. State estate tax rates vary from 12 percent to 20 percent, and state exemptions range from $1 million to $5.6 million. An estate valued at $10 million, for example, is exempt from federal estate tax but could be subject to a state estate tax.

Estate growth. Appreciating assets in an estate have the potential to generate a future estate tax need. Estates that include rapidly appreciating real estate or ownership of a growing business interest are at risk for an increasing estate tax need. As such, a review of the composition of assets in your client’s estate should be performed.

The advantages. Trusts provide a variety of benefits, such as asset and creditor protection to both the one who gifted the assets and the beneficiaries. If the client has minor children as beneficiaries, an ILIT can help manage and protect the assets on behalf of those children. ILITs also avoid the expense and inconvenience of probate. Rather than outright gifts to a beneficiary who is not financially savvy, the trustee of an ILIT can responsibly manage the funds to protect future benefits for the beneficiary.

Inheritance equalization and liquidity. Life insurance can help with inheritance equalization and provide needed liquidity during difficult times. Often, estates hold illiquid assets or assets that are difficult to divide (e.g., real estate or a business interest). The liquidity provided by life insurance can help equalize inheritance among beneficiaries by providing cash to those beneficiaries who are not involved in the business. With real estate and other illiquid assets, the client could provide property to one beneficiary and cash from the life insurance to another. This reduces the possibility of having to sell the property to divide the inheritance among multiple beneficiaries. In down markets, rather than having to sell the property for a loss to pay the estate taxes or divide it for inheritance, life insurance can provide liquidity at just the right time.

Gifts. When assets are gifted into an irrevocable trust, clients generally use annual exclusions or part of their lifetime gift tax exemption to mitigate or eliminate gift tax. In properly structured irrevocable trusts, these assets no longer belong to the client and are not countable for estate tax. Therefore, termination of an ILIT would result in the distribution of assets to the beneficiaries, rather than returning assets to the client.

The factors listed here can be used as a framework to guide your conversations with clients when discussing if they still need an ILIT. But to take a deeper dive, you need to have all the facts.

The Deeper Dive

As you know, each client has different goals, and determining the need (or not) for an ILIT will require asking the following questions.

Future legislation

• Are you aware that the estate tax exemption may revert to a lower amount beginning in 2026? How comfortable are you with that risk?

• What estate tax rate and exemption would you like to plan for?

Financial

• What is your current net worth? How much do you estimate your net worth will grow to in 5 years, 10 years, 20 years, 30 years, or 40 years?

• What kinds of assets are included in the estate? Do you own rapidly appreciating property? Does the estate include illiquid assets?

• Do you own a growing business?

• What state do you reside in? Is there an applicable state estate tax?

Family and beneficiary

• What family dynamics are important to consider?

• How many beneficiaries are part of the inheritance? What are their ages? Are any of the beneficiaries minor children?

• Are there illiquid assets that will need to be split between multiple beneficiaries?

• Are the beneficiaries responsible? Are they capable of making good financial decisions on their own?

• What is your family history of longevity? How do you view your own longevity?

What if an ILIT Is No Longer Necessary?

Once you’ve asked the right questions and uncovered the relevant answers, your client may decide that an ILIT no longer makes sense. Now what? Working with an attorney, your client does have the option to modify or terminate an ILIT.

Modification. In certain circumstances, a trust can be changed or modified within its terms and in compliance with state laws to better achieve the desired results. Here, a commonly discussed strategy is trust decanting. With trust decanting, if the state law allows, one trust can be poured over into another trust with updated terms more relevant to current circumstances.

Termination. An irrevocable trust generally can’t be terminated. But under certain circumstances, an ILIT can be terminated with the assistance of an attorney. Some states require judicial intervention to terminate an ILIT. Other states have statutes that allow a termination if all parties—the grantor, all beneficiaries, and the trustee—agree.

What About the Life Insurance?

Prior to liquidating and distributing assets in an ILIT, the decision should be analyzed with an attorney to ensure that the trustee continues to meet his or her fiduciary responsibility to the beneficiaries. The analysis should include a review of any existing life insurance policies in the ILIT. The trustee will need to evaluate the life insurance potential death benefit, the policy structure, and the future premiums needed to maintain the policy to determine whether to keep the policy, surrender it, or allow the policy to lapse. Reviewing the age and health of the insured(s) on the policy will be helpful to project anticipated longevity and life expectancy to decide if it makes sense to relinquish the potential death benefit. If the cash value is greater than the cost basis in the policy, it will create a taxable gain if the policy is surrendered.

Of course, there could be reasons the client may want to retain the policy. If the insured on the policy has experienced health concerns since the policy was issued, it will limit his or her ability to obtain a new policy at a similar insurance rating or at all. Older policies issued at younger ages, with preferred health ratings, generally have lower premium requirements and are desirable to preserve. When there are other insurance needs for the insured, either personal or business, consider transferring or selling the existing policy out of an ILIT to meet that need. With ILITs that contain a power to substitute assets, the policy could be substituted out of the ILIT for an asset of equivalent value.

Decisions, Decisions

These are just a few of the possibilities to consider when helping your clients make decisions about whether they still need an ILIT. We know that the future of estate tax rates and exemptions is uncertain. But depending on the family dynamics, characteristics of the assets included in the client’s estate, and the needs of the client, an ILIT may continue to be beneficial. As always, before making any decisions, a best practice is for clients to review the specifics of their situation with their legal advisor.

Commonwealth Financial Network® does not offer legal or tax advice.