Why Establish an Irrevocable Life Insurance Trust?
Irrevocable life insurance trusts are one of the most effective strategies for preserving wealth, minimizing estate taxes, and ensuring your legacy passes to the next generation.
If you have a life insurance policy, you can set up an ILIT to remove it from your taxable estate, which gives your beneficiaries liquidity instead of a tax burden when you pass.
What is an Irrevocable Life Insurance Trust?
An Irrevocable Life Insurance Trust is a trust designed to own and be the beneficiary of your life insurance policy. Transferring ownership of your life insurance policy to the trust removes it and its eventual death benefit from your estate.
After the trust becomes the policy owner and beneficiary, you continue making premium payments through annual gifts to it. After you pass, the death benefit flows directly into the trust, which then gets distributed to your beneficiaries.
Because the policy is removed from your estate, its proceeds are transferred without being taxed.
Why Establish an Irrevocable Life Insurance Trust?
The main reason people establish ILITs is for estate tax reduction and wealth transfer efficiency.
Let’s say you own a $5M life insurance policy and have an estate valued at $15M. Your total estate is $20M, which would subject $6.39M to federal estate taxes. By establishing an ILIT and transferring the life insurance policy to it, the estate drops to $15M, potentially saving $2M in taxes.
ILITs also provide liquidity. Most high-net-worth families have non-liquid assets like real estate or businesses. Sometimes, families can be forced to sell their non-liquid assets below FMV to cover their estate taxes. The liquidity from life insurance proceeds from the ILIT can help cover this cost.
ILITs also allow for sophisticated wealth transfer strategies. Parents can pay the ILIT’s life insurance premiums using annual gift tax exclusions ($19k per recipient in 2025), basically transferring wealth to beneficiaries at a discount.
Tax Implications
Three Year Rule
The most significant tax benefit of ILITs is that they remove life insurance proceeds from the federal estate tax calculation. However, this only applies if the grantor lives for at least three years after transferring their policy to the trust. If you pass sooner, the IRS includes the death benefit in your taxable estate. To avoid the three year waiting period, some planners recommend having the trust purchase new policies instead of transferring the existing ones.
Gift Taxes & Crummey Powers
Each premium paid counts as a gift to the trust beneficiaries. To qualify for the annual gift tax exclusion, the beneficiaries must have immediate access to these funds. ILITs accomplish this through "Crummey powers," which give beneficiaries a limited time window (30-60 days) to withdraw their share of each contribution. Without the Crummey withdrawal, premium payments would be gifts of “future interests,” requiring the use of lifetime gift tax exemptions rather than annual exclusions.
Other Taxes
Generation-Skipping Transfer Tax: If an ILIT benefits grandchildren or later generations, it may be subject to the 40% GST tax.
Income Tax: ILITs receive the death benefit income tax free, the same as individual beneficiaries would. However, if the trust generates income from insurance policy cash values or investments, it may owe income taxes at compressed trust tax rates.
Potential Disadvantages of ILITs
Premiums
Life insurance premiums must be paid annually to keep policies in force, and these typically increase over time. Funding these premiums can create cash flow issues.
Crummey Powers
Beneficiaries must be notified of their withdrawal rights each year and if someone exercises them, it can disrupt the trust's funding.
Liquidity
Life insurance policies can accumulate significant cash values, but they stay in the trust. You cannot access these funds for personal use, even in an emergency.
Investment Risk
The performance of some life insurance policies (universal life or variable life) depend on investment returns. If there is poor ROI, it can negate the purpose of the ILIT.
ILIT Design Considerations
Choosing the Right Life Insurance Policy
Term life insurance: Lowest initial cost but may become expensive later on.
Whole life insurance: Has guaranteed premiums and death benefits but typically offers lower internal returns.
Universal life insurance: Has flexibility but requires ongoing monitoring to ensure adequate funding.
Variable life insurance: Gives you investment control but exposes you to market risk.
Distribution Provisions
Some families prefer mandatory distributions at specified ages, while others prefer discretionary distributions based on beneficiary needs and trustee judgment.
Funding the ILIT
Annual exclusion gifts are the most tax-efficient funding method, but some situations may warrant larger gifts using lifetime exemptions. The timing and structure of these impact the trust's tax efficiency.
Who should consider an ILIT?
High Net Worth Families
Families with large estates who face potential estate tax burden and need life insurance for wealth replacement or liquidity should consider an ILIT. They are particularly effective when established by younger, healthier members of the family who can purchase a life insurance policy at a better rate and survive the three-year waiting period.
Business Owners
Business owners often use ILITs in their succession planning. The trust can provide liquidity for estate taxes while ensuring that their business remains intact and under family control.
Multigenerational Planning
Families engaging in multigenerational wealth planning often combine ILITs with generation-skipping tax planning. This helps younger generations minimize transfer taxes for efficient wealth transfer.
Irrevocable Life Insurance Trusts are powerful tools for those who want to preserve wealth, minimize estate taxes, and ensure efficient wealth transfer to their future generations.
They require coordination with estate planning attorneys, tax professionals, insurance specialists, and financial planners.
As always, we recommend working with a tax professional who understands both tax strategies and wealth management.
Questions answered in this blog:
What is an Irrevocable Life Insurance Trust?
How can an Irrevocable Life Insurance Trust reduce estate taxes?
If my life insurance policy goes into my Irrevocable Life Insurance Trust, who gets the death benefit when I pass?
How does an Irrevocable Life Insurance Trust give my beneficiaries more liquidity?
What is the 3 year rule for Irrevocable Life Insurance Trusts?
What if I pass sooner than 3 years after transferring my life insurance policy to my ILIT?
Can the funds from my ILIT go tax free to my grandchildren?
Are both the death benefit and income from my life insurance policy’s cash value tax exempt if my policy is in an ILIT?
What are disadvantages of an ILIT?
When I establish an ILIT, should I use a term life insurance policy?
When I establish an ILIT, should I use a whole life insurance policy?
When I establish an ILIT, should I use a universal life insurance policy?
When I establish an ILIT, should I use a variable life insurance policy?
Why do high net worth families use ILITs?
What are the benefits of an ILIT for business owners?
How does an ILIT help with succession planning?