Irrevocable Life Insurance Trust (ILIT)

An Irrevocable Life Insurance Trust (ILIT) removes life-insurance proceeds from your taxable estate while preserving liquidity to pay estate taxes after your death. The mechanics turn on three pieces: who owns the policy, the IRC § 2035 three-year rule, and Crummey-power gift-tax discipline.

In a previous post, I discussed the role life insurance can play in an estate plan. In this post I will discuss a more complex estate-planning tool: the irrevocable life insurance trust, or ILIT.

Tax Considerations of the Irrevocable Life Insurance Trust

If the individual insured by a life-insurance policy has an estate worth more than the estate-tax exclusion — $15,000,000 per individual as of 2026, or $30,000,000 for a married couple using portability — life-insurance proceeds owned by the insured will be added to the taxable estate at death. For estates large enough to face that problem, having someone other than the insured own the policy becomes important.

An ILIT solves the ownership problem in a structured way. If drafted and funded correctly, an ILIT can remove the life-insurance proceeds from the estate of the insured (and, if applicable, the surviving spouse), keep the proceeds available to pay estate taxes due after the insured’s death, minimize gift-tax liability through Crummey powers, reduce or eliminate generation-skipping transfer tax exposure, and preserve flexibility through broad trustee discretion.

Ideally, the ILIT’s trustee — not the insured — purchases the policy from inception. If the insured purchases the policy first and then transfers it to the trust, IRC § 2035 pulls the policy back into the insured’s taxable estate if the insured dies within three years of the transfer. If the trust buys the policy directly, the three-year lookback never applies.

When setting up an ILIT, an independent trustee — someone other than the insured or the beneficiary — is essential. The independent trustee can exercise the “incidents of ownership” over the policy (the right to change the beneficiary, surrender the policy, borrow against its cash value) without implicating the estate tax under IRC § 2042. A surviving spouse can serve as a trustee of an ILIT, but cannot transfer assets into the trust and cannot have a policy on his or her own life held in it.

Whenever estate-planning tools are used to mitigate estate-tax liability, the gift tax is the corresponding concern. A taxable gift occurs when the policy is transferred into the trust (if the policy has a cash value) or when premium funds are transferred into the trust. An ILIT minimizes gift-tax exposure with Crummey powers, which give beneficiaries the temporary right to withdraw premium contributions and thereby qualify those contributions for the annual gift-tax exclusion ($19,000 per donee in 2026).

As discussed in the post on Crummey trusts, however, Crummey powers must be drafted carefully. With multiple beneficiaries, even using the full annual exclusion can produce taxable gifts to the other beneficiaries when one beneficiary fails to exercise their withdrawal rights. The ILIT is not a do-it-yourself trust.

Drafting Considerations for an ILIT

When drafting an ILIT, several principles should guide the work:

1. The insured must not retain any “incidents of ownership” over the policy.
2. All policies should be assigned to the trustee.
3. The trust documents should preclude the insured from ever serving as a trustee.
4. The trust cannot allow its assets to be applied toward any support obligations the grantor may have.
5. The trust agreement should completely dispose of all interests in the policy, so that it cannot revert back to the grantor.
6. To soften the rigidity of an irrevocable trust, a trust protector can be added with the power to amend administrative provisions, change trustees, decant to a new trust, or terminate the trust. The trust agreement should specify when the protector may exercise these powers, or grant the protector “sole and absolute discretion.”
7. The policy owner — or the policy owner’s estate — should not be the primary beneficiary, or gift-tax consequences will follow.

A trust protector is a fiduciary granted powers separate from those of the trustee, often including the power to change the trustee, amend administrative provisions, transfer assets to a new trust, or terminate the trust. The role of the trust protector is to ensure that the grantor’s intent is honored, providing a check against a trustee who becomes unscrupulous, incompetent, or simply inattentive.

Disclaimer: This post is for informational purposes only and is not legal advice. ILIT drafting interacts with IRC §§ 2035, 2036, 2042, the Crummey doctrine, state trust law, and the rapidly changing federal estate-and-gift-tax thresholds; consult a qualified estate-planning attorney about your situation.

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