Another common type of trust is an Irrevocable Life Insurance Trust (ILIT). Essentially, it is a trust which holds only life insurance. The purpose of the life insurance trust is to keep the insurance proceeds from being included in the calculation of the gross estate.
Recall that earlier, we discussed estate tax and how it is based on the size of one’s estate upon death. If the decedent owned life insurance upon his death, those insurance proceeds are included in his estate. For many families, that could be very costly. For example, the estate tax exemption limit is $1 million. So if the father died with $2 million in life insurance, and no other assets, his heirs would only receive $1.5 million in proceeds ($1 million is exempted, the remainder is taxed at roughly 50% for a total of $500k). If the insurance were owned inside an irrevocable life insurance trust, the entire $2 million of life insurance proceeds would not be included in the estate to begin with.