What Is an Irrevocable Life Insurance Trust (ILIT)?

Life insurance is one of the most valuable tools in estate planning. It can provide financial security for your loved ones, replace lost income, create liquidity to pay expenses after death, and help preserve your family’s wealth for future generations.

Many people are surprised to learn that although life insurance proceeds are generally received income tax-free, they are still included in your taxable estate if you own the policy. For individuals and families with larger estates, this could increase the amount of federal estate tax that will be owed.

One way to plan in advance for this is through an Irrevocable Life Insurance Trust (ILIT).

What Is an ILIT?

An Irrevocable Life Insurance Trust is a specialized trust that owns a life insurance policy instead of you owning it personally.

When properly established, the ILIT becomes both the owner and beneficiary of the policy. Because you do not own the policy, the life insurance proceeds are generally excluded from your taxable estate, while providing financial benefits for your loved ones and can help plan for an eventual estate tax liability.

An properly established and funded ILIT can provide cash to:

Pay estate taxes and administrative expenses
Provide income for your spouse or children
Protect assets for future generations
Preserve family wealth without forcing the sale of valuable assets (such as real estate or a family business)

Why Do People Use Life Insurance?

Life insurance serves many purposes beyond simply replacing income.

It can also help:

Provide financial security for your family
Replace the income of a primary wage earner
Pay off debts or a mortgage
Create an inheritance for children or grandchildren
Help equalize inheritances among family members

For families with businesses, investment real estate, or other valuable assets, life insurance can also prevent heirs from having to sell property quickly just to raise cash after a death.

Types of Life Insurance

Several types of life insurance may be used in estate planning including:

Term Life Insurance provides coverage for a specific period, such as 20 or 30 years, and is generally used for temporary needs.

Permanent Life Insurance, including whole life and universal life, is designed to remain in force for life and is often used in long-term estate planning.

Survivorship (Second-to-Die) Life Insurance insures two spouses and pays the death benefit after the second spouse dies. Because estate taxes often are not due until both spouses have passed away, these policies are commonly used in estate tax planning.

Why Ownership Matters

One of the biggest misconceptions about life insurance is that the proceeds are always free from taxes. While the death benefit is generally income tax-free, if you own the policy at your death, its value is typically included in your estate for estate tax purposes.

An ILIT helps avoid this by having ownership of the policy  be the irrevocable trust, not you individually. Whenever possible, it is usually best for the ILIT to purchase a new policy rather than transferring an existing policy to the trust. This helps avoid the IRS three-year rule, which may pull the insurance proceeds back into your estate if you were to die within three years of transferring an existing policy.

Benefits of an ILIT

A properly drafted ILIT can provide several important benefits, including:

Removing life insurance proceeds from your taxable estate
Providing liquidity to pay estate taxes and expenses
Protecting beneficiaries from future creditors, lawsuits, bankruptcy, and divorce
Holding assets in trust for children or grandchildren
Providing for a surviving spouse’s health, education, maintenance, and support
Coordinating with your overall estate plan

Who Should Consider an ILIT?

An ILIT may be appropriate if you:

Have a net worth approaching or exceeding the $15 million federal estate tax exemption ($30 million if you are married)
Own a successful business
Have significant real estate or investment assets
Already own a substantial life insurance policy
Want to protect life insurance proceeds for future generations
Are looking for advanced estate tax planning strategies to help plan for the care of loved ones

Even if your estate is currently below the exemption, future appreciation or changes in tax laws could make an ILIT an important planning tool.

Example

Bob is a 65-year-old widower with two adult children and an estate worth approximately $18 million.

Because the current federal estate tax exemption is $15 million (2026) per person, approximately $3 million of Bob’s estate could be subject to federal estate tax.

To help address this, bob establishes an Irrevocable Life Insurance Trust and makes a trusted friend as the trustee of the ILIT. Bob makes an initial gift of money to the trust and records the gift on a 709-gift tax return. Then the trustee purchases a new life insurance policy owned by the ILIT on Bob’s life. Bob plans to make annual gifts to the trust to pay the premiums.

Each year, the trustee sends Crummey Notices to the beneficiaries so Bob’s gifts qualify for the annual gift tax exclusion (making them gifts of a “present interest”).

When Bob passes away, the life insurance proceeds are paid directly to the ILIT, not to Bob’s estate. The trustee can then use those funds to provide liquidity, pay estate taxes or administration expenses, or continue managing the assets for Bob’s children according to the trust’s terms.

Is an ILIT Right for You?

While today’s $15 million federal estate tax exemption means fewer families owe federal estate tax than in the past, advanced planning is still important for many successful individuals and families.

An Irrevocable Life Insurance Trust can help plan for estate taxes, protect your beneficiaries, provide liquidity when it is needed most, and preserve the wealth you’ve worked so hard to build. If you have a larger estate, own significant life insurance, or want to explore sophisticated estate planning strategies, an experienced estate planning attorney can help determine whether an ILIT should be part of your overall estate plan.

If you, a friend, or a loved one needs help establishing or updating an estate plan, or discussing advanced estate planning, we’re here to help. Contact our Intake Department at 760-448-2220 or visit us online at www.geigerlawoffice.com/contact.cfm. We proudly serve families across California from our offices in Carlsbad (San Diego County) and Laguna Niguel (Orange County).