Most people purchase a life insurance policy at some point. Often, life insurance is offered as part of employment or as part of affiliation with a union or other group. The basic function of all life insurance is to provide financial security to a beneficiary upon your death. Although the basic purpose of life insurance is accomplished by all types of life insurance, it pays to understand the difference between the two main types of life insurance from a financial perspective.

Life insurance comes in two basic types — term and permanent life insurance. Variations of the two main types have evolved over the years, but understanding the principal differences between term and permanent life insurance policies is a good place to start.

A term life insurance policy is purchased solely for the purpose of providing money to a beneficiary, or beneficiaries, upon your death. A term life insurance policy is not an investment. All policy premiums are lost once paid, meaning the policy does not accrue equity. The benefit to a term life insurance policy is generally the lower cost of the premiums. Because a term life insurance policy does not offer any growth on the capital invested, the premiums are usually significantly lower than premiums for a whole life policy.

A permanent life policy, on the other hand, offers both financial security for loved ones as well as investment potential for the policy owner. While a permanent life insurance policy does provide benefits upon the death of the insured, it can also provide a cash reserve that can be accessed at any time by the policy holder. A “loan” can be taken out against the value of the policy by the policy holder once enough funds have accrued in the form of premium payments. Premiums are often higher for permanent life insurance policy, but are also typically fixed.

Pyke & Associates, P.C. is a member of the American Academy of Estate Planning Attorneys.

An Irrevocable Life Insurance Trust, or ILIT for short, is a Trust used to hold your life insurance policies and receive policy disbursements after you pass away.

Understand the Benefits

There are many benefits to using an ILIT. First, you can provide your family with asset protection. If you name a direct heir instead of a Trust as the beneficiary of your policy, your heir runs the risk of having those funds taken to settle your heir’s lawsuits or debts.

An ILIT also offers safety from estate taxes. With the 2011 tax exemption expected to return to the low level of one million dollars, larger policies may throw estates over the exclusion limit. By placing your policy into an ILIT, it will be free from the estate tax burden. This is because your estate do not directly own the policy funds at your death.

Your ILIT also provides a way to spread inheritances out over many years. A slow disbursement of life insurance funds could provide your loved ones with a steady income. You can even turn your ILIT into a Dynasty Trust to provide funds to the heir’s of your beneficiaries.

If you are in a blended family, an ILIT can provide inheritance protection for your children. During the rest of your spouse’s life, he or she will receive payments from the ILIT, but your children will fully inherit after your spouse’s death. This assures your life insurance funds will remain with the heirs you have chosen.

Creating the Trust

When you create an ILIT, you will name the Trust as the beneficiary of your Life Insurance policies. Within the ILIT you can create individual Trusts for each family member. Once you have created the ILIT, the terms cannot be changed because it is Irrevocable, so be sure of your intentions before you create an ILIT.

Pyke & Associates, P.C. is a member of the American Academy of Estate Planning Attorneys.