Why Irrevocable Life Insurance Trusts (ILITs) are Dead for Most Tennesseans

An irrevocable life insurance trust (ILIT) is a trust that when properly drafted and funded removes life insurance proceeds from a decedent’s estate. This means none of the life insurance proceeds are subject to Tennessee inheritance taxes or federal estate taxes.

Wow. What a great deal. Until recently, integrating ILITs into the estate plans of Tennesseans was for very good reason a common practice.

However, much to the benefit of Tennessee residents, in recent years our death tax exemptions have dramatically increased causing the ILIT’s effectiveness in reducing death taxes for the average Tennessean to wane.

In 2012, Governor Haslam and Tennessee’s General Assembly enacted legislation phasing out Tennessee’s inheritance tax by 2016. At the federal level President Obama signed into legislation making permanent the federal estate tax exemption at $5,430,000 (2015) with annual increases tied to inflation and “portability” for married couples. In 2016 Tennessee residents will not be subject to death taxes unless the value of their estate exceeds approximately $5,430,000, if single, or $10,860,000 if married.

The current (2015) Tennessee inheritance exemption is $5M, but will go away next year and is typically due only at the second spouse’s death due to the unlimited marital deduction.

Ten years ago in 2005, the federal estate tax exemption was $1.5M with a top tax rate of 47%. In 1997 it was $600K with a top tax rate of 55%. In 2005 Tennessee’s inheritance tax exemption was $950K. Tennessee has a top inheritance tax rate of 9.5%.

To give some perspective, if in 2005 a single person died who was debt free and individually owned a modest house, a couple of modest retirement accounts, and maybe a taxable brokerage account or two, which taken all together grossed $950K and also individually owned $1.5M life insurance policy ($950K + $1.5M = $2.45M) the decedent’s children were forced write big checks to the Tennessee Department of Revenue and Uncle Sam.

Without utilizing an ILIT the children were hammered with death taxes applicable to the $1.5M in life insurance proceeds. With a combined maximum death tax rate of 56.5% this was significant.

In the alternative, if this person sought sound legal advice and properly established an ILIT the $1.5M in life insurance proceeds would be excluded from their estate and not subject to death taxes.

For these reasons, ILITs were very popular and effective tools at reducing death taxes — sometimes to the tune of hundreds of thousands of dollars and in some cases millions of dollars.

Fast forward to 2015 and our current death tax exemptions, Tennesseans generally will not benefit from an ILIT unless single with an estate value exceeding approximately $5M or married with a combined estate exceeding $10M.

Most Tennesseans do not have potentially taxable estates. According to the Center on Budget and Policy Priorities only 1.4 out of every 1,000 estates (0.14%) were subject to federal estate tax in 2013.

For most Tennesseans, in today’s environment with high death tax exemptions, there are minimal tax advantages to utilizing an ILIT in their estate plans. However, for those Tennesseans fortunate enough to have potentially taxable estates, with a top death tax rate of 45%, ILITs remain an extremely effective estate planning tool.

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