What is an Irrevocable Life Insurance Trust (ILIT)?
An Irrevocable Life Insurance Trust (ILIT) is a legal entity that owns and controls one or more life insurance policies outside of your taxable estate. Placing the ownership of a life insurance policy in an ILIT can help manage estate taxes, provide liquidity for heirs, and control how and when proceeds are distributed after death.
In this Insight, we explore how ILITs work, important rules and regulations, and how to assess whether they could be a fit for your personal financial plan.
Interested in a broader look at estate planning priorities? Take advantage of our Checklist for Organizing & Settling an Estate.
How does an ILIT work?
While life insurance proceeds are generally not subject to income tax, they are typically counted as part of your estate for estate tax purposes. An Irrevocable Life Insurance Trust (ILIT) can be structured to keep those proceeds outside of your taxable estate, which may significantly reduce or eliminate federal estate taxes. This makes ILITs a valuable tool for preserving wealth across generations.
Once the trust is established, the individual creating it (known as the grantor) must give up control of the policy and appoint an independent trustee to oversee the trust. The trust document dictates how the insurance proceeds will be managed and distributed to beneficiaries, often with the added benefit of shielding those assets from creditors. To maintain these protections, the ILIT must be carefully managed according to IRS guidelines and trust provisions.
Key Details When Establishing and Funding an ILIT
To ensure the life insurance proceeds are excluded from the estate, the ILIT should be both the owner and the beneficiary of the policy. If an existing policy is transferred into the trust, the grantor must live for at least three years after the transfer for the proceeds to be excluded from the estate, a rule that can complicate planning.
In some cases, it may be possible to sell the policy to the ILIT instead, which can help avoid this three-year look-back requirement. Whenever possible, the most effective approach is often to have the ILIT purchase the policy from the start.
Clarify Generation-Skipping Transfer (GST) Tax Intentions
An ILIT can be structured to avoid transfer taxes not only at the grantor’s death, but also at the death of future beneficiaries. To accomplish this, you’ll need to decide whether to allocate a GST exemption or elect out. This is particularly relevant if grandchildren or future generations are among the trust’s beneficiaries.
Identify Whether the ILIT Will Be a Grantor or Non-Grantor Trust
In a grantor trust, the grantor is responsible for the trust’s income taxes, which can allow the trust assets to grow without erosion from tax payments. Non-grantor trusts are taxed separately. The choice affects both tax strategy and reporting obligations.
Confirm Whether the Trust Needs a Separate Tax ID (EIN)
Some ILITs require their own tax identification number (EIN), especially if structured as non-grantor trusts or when holding a separate bank account. This allows the trust to file returns or manage assets independently of the grantor’s personal tax filings.
Administer “Crummey Notices” and Premium Payments Carefully
Each time a gift is made to fund the life insurance premium, beneficiaries must receive written notice of their withdrawal rights (a “Crummey letter”). These letters help validate the tax treatment of the gift and must be documented appropriately.
Crummey powers let beneficiaries temporarily access contributions made to the trust, making those contributions qualify for the annual gift tax exclusion. Without this provision, gifts to the trust may reduce your lifetime gift and estate tax exemption.
Consider Opening a Trust-Owned Bank Account
A checking account in the name of the ILIT allows the trustee to receive annual contributions and pay the insurance premium directly from the trust. This can help preserve the legal separation between the grantor and the trust for estate tax purposes.
Other Recommendations
We recommend that you maintain both physical and digital copies of the ILIT documents, along with the most recent policy statements. It’s also advisable to retain records of premium payments and any correspondence involving the trustee, beneficiaries, attorney, and financial advisor.
Regular Life Insurance Policy Review for ILITs
Trustees of ILITs have a fiduciary responsibility to periodically review the trust’s insurance policies to ensure they remain appropriate for the trust’s objectives. For permanent life insurance, this may include evaluating the policy’s performance through updated in-force illustrations, reviewing whether premiums can be funded using accumulated cash value, and confirming the financial strength of the insurance carrier.
In the case of variable policies, the trustee should also assess the investment selections for suitability. For term policies, it’s important to monitor the policy’s expiration date and determine whether conversion to permanent coverage is warranted. If the trust holds assets besides life insurance, those assets should also be reviewed to ensure they are appropriately managed.
Aligning Estate Planning Tools with Your Broader Financial Goals
An Irrevocable Life Insurance Trust (ILIT) can be a powerful estate planning strategy, but it requires careful design, administration, and integration with your broader financial planning. A trusted advisor can help you determine whether an ILIT is appropriate for your goals, evaluate policy funding strategies, and coordinate with legal and tax professionals to ensure long-term effectiveness.
Interested in learning more about how ILITs fit into your estate planning options? You can access our educational guide and ILIT checklist here.
Looking for guidance tailored to your financial situation? Schedule a complimentary 30-minute consultation with one of our advisors today.