For many years, irrevocable life insurance trusts (ILITs) have been a staple of estate planning.

Do they still make sense, now that the federal estate tax exemption is north of $5 million (effectively $10 million plus for married couples)? Some advisors believe in holding onto ILITs. “We have not seen insurance being dropped because of the federal estate tax exemption increase,” says Norman “Skip” Santori of Santori & Peters, a wealth management firm in Monroeville, Penn.

In a typical scenario, Joe Client would anticipate a $2 million estate tax obligation. Joe wouldn’t want his heirs to have to sell the family business or investment property to pay the tax so he would create an ILIT to hold a $2 million insurance policy on his life. At Joe’s death, the ILIT would collect $2 million, avoiding income as well as estate tax, and provide cash for the estate tax bill so that Joe’s assets could pass intact to his heirs.

Under current law, though, relatively few clients will owe substantial amounts of estate tax. If that’s the case, does it make sense to hold onto an existing ILIT? Yes, according to Santori. “I still use this trust for middle-class millionaires and those clients with more assets,” he says. Santori defines middle-class millionaires as those with net worth in the $1 million-$10 million range.

Santori recommends putting a “trap door” on an ILIT. “That means the insurance money paid to the ILIT is held in the ILIT until the surviving spouse dies,” he says. “The surviving spouse has access to the trust for health, education, maintenance and support if needed; the trust principal is not includable in the survivor’s estate. At the death of the survivor the trust begins paying distributions to the ILIT beneficiaries, as directed, which could be either a lump-sum or in installments. Using the ILIT avoids federal and state inheritance taxes as well as probate.”

Why the ongoing concern with federal estate tax? Santori relates attending some major conferences recently where “no speaker, not one, thinks taxes, federal or state, are going down any time soon.” Santori believes that tax rates are going up and tax exemptions are either going away or scaling down.

Clients agree with this view, Santori reports. “People don’t trust that the exemption will hold,” he says. “How many times have the politicians toyed with estate taxes? If there is any need for life insurance—for legacy planning or to provide for a surviving spouse--then an ILIT is still a great way to provide this additional layer of insurance protection. The ILIT is an excellent tool for wealth transfer no matter what the politicians, both federal and state, do with the tax code.”

Donald Jay Korn

Donald Jay Korn is a New York-based financial writer who contributes to Financial Planning and On Wall Street.