Using Insurance Trusts to Enhance Financial Flexibility, Control, and Tax Efficiency in Your Estate Planning
1. Comprehensive Introduction to ILITs
While you may have spent a great deal of your life thinking about offense (by saving, investing, and building your net worth), it is equally important to think about defense (implementing measures to protect what you have built). A key part of your defensive strategy is deciding what will happen to your assets once you (and your spouse, if applicable) are no longer here.
Without proper estate planning, everything you’ve worked for could be significantly reduced by unnecessary taxes, court probate costs, complications, creditor claims, and other potential threats. Your hard-earned assets may be distributed according to state lawโand the recipients may not necessarily be who you intended.
One powerful defensive strategy is using a properly structured Irrevocable Life Insurance Trust (ILIT).
What is an Irrevocable Life Insurance Trust?
An Irrevocable Life Insurance Trust (ILIT) is a type of irrevocable trust set up by a “trustmaker” to be the owner and beneficiary of one or more life insurance policies. Upon the insured’s death, the trustee invests the insurance proceeds and administers the trust for one or more beneficiaries.
The dual purpose of an ILIT is to:
- Provide for beneficiaries (often younger generations)
- Enable estate tax planning through strategic “gifting”
The Current Estate Tax Landscape (2025)
As of 2025, the federal estate tax environment includes:
- Exemption Amounts: $13.99 million per individual ($27.98 million for married couples)
- Sunset Provision: Exemptions revert to approximately $7 million (inflation-adjusted $5M base) on January 1, 2026
- Tax Rate: 40% on amounts exceeding the exemption
This pending reduction in exemption amounts in 2026 makes ILITs particularly relevant for many families in the coming year.
2. Context About Trusts Generally
Revocable versus Irrevocable Trusts
As a bit of background, a trust is a type of legal device often used for managing assets and/or property. Through a trust, one individualโthe grantorโtransfers the legal title to another (the trustee), who then manages it in a specified manner for the benefit of a third party, or beneficiary. There are both revocable and irrevocable trusts.
Revocable Trusts
Revocable Trusts
With a revocable trust, you are allowed to retain full control of all assets placed into the trust. You have the freedom to change or “revoke” the terms and conditions at any time.
Therefore, if you have second thoughts about any provisions in the trust, they may be modified. Similarly, if major life changes occurโsuch as divorceโyou have the freedom to make necessary changes, such as revising beneficiary designations.
One of the most popular revocable trusts is the living trust. Revocable trusts are common planning tools if your goal is to avoid probate, as assets in a revocable trust pass directly to beneficiaries upon your passing.
However, because you (the grantor) are still considered the owner of the property and assets in a revocable trust, they will be included in your estate for tax purposes. Additionally, these assets may be at risk if you are sued or file for bankruptcy.
Irrevocable Trusts
Conversely, an irrevocable trust does not allow you to have full control of the assets inside it. You cannot make changes without the consent of beneficiaries, and the trust generally cannot be terminated once created. The ILIT falls into this category.
The “tradeoff” for this inflexibility is that assets in an irrevocable trust are no longer considered owned by you. Therefore, at your passing, these assets will NOT be included in your estate value, nor will they be subject to estate taxes. This is one of the MAIN REASONS why irrevocable trusts are used in estate planning.
Holding assets in an irrevocable trust can also be beneficial during your lifetime, as these assets are generally protected from creditors.
Comparison: Revocable vs. Irrevocable Trusts
| Feature | Revocable Trust | Irrevocable Trust |
|---|---|---|
| Flexibility | Terms may be changed during your lifetime | Terms are locked in when the trust is created |
| Control | You retain total control over assets in the trust | You do not have control of assets once they are in the trust |
| Estate Tax | Heirs could still be subject to estate taxes | No tax is levied on the assets inside the trust |
| Protection from Creditors | Not protected from creditors or lawsuits | Offers protection from lawsuits and creditors |
3. Detailed Explanation of How ILITs Work
Creation of an ILIT
An ILIT is a trust agreement that should be drawn up by an experienced estate planning attorney. Any trust is complicated to prepare (especially irrevocable trusts), and there may be consequences for DIY estate planning if the ILIT is not set up correctly.
The trust agreement needs to:
- Include specific terms and conditions important to the trustmaker
- Comply with current tax laws to ensure it will pass IRS scrutiny
- Designate beneficiaries who will receive the trust assets upon the insured’s death
Purchasing Life Insurance
The trustee of the ILIT should purchase the insurance on behalf of the trust RATHER THAN assigning an existing policy. If an existing policy is assigned to an ILIT, the IRS will require that the proceeds are still part of your estate if you die within 3 years of the transfer.
Term Life vs. Permanent Life Insurance for ILITs
There is debate about which type of life insurance is best for ILITs:
Term Life Considerations:
- Lower premiums
- Fixed term (typically 10-30 years)
- No cash value
- May be suitable for short-term needs
Permanent Life Considerations:
- Higher premiums
- Lifetime coverage
- Accumulates cash value
- Better suited for multi-generational planning
The decision may hinge upon how much death benefit the trustmaker qualifies for, whether a long-range term policy is available to cover the lifespan of the trustmaker, and the specific estate planning goals.
Funding the ILIT through Gifting
In general, gifting money or assets to another person, other than a spouse, is a taxable event. However, each person is allowed to gift a certain amount per beneficiary every year without any gift tax issue. That amount as of 2025 is $18,000 per beneficiary.
Because ILITs are separate legal entities, money can be gifted to the trust and then used to pay premiums. For example, if the ILIT has 3 beneficiaries, then $54,000 could be gifted to the trust ($18,000 x 3) each year. That $54,000 could be used to pay the premiums on a life insurance policy, with the death benefit to pass to the 3 beneficiaries.
Crummey Powers and Notifications
A potential complication occurs when gifting insurance policy premium payments to ILITs. The IRS only allows this to constitute a gift if the beneficiaries have a current right to the gift. When there is a gift to a trust, the beneficiaries are offered a future benefit which they may or may not realize.
This issue was addressed in the “Crummey case.” When assets are gifted to ILITs, the trustee must send a “Crummey letter” to the beneficiaries, typically providing a 30-45 day window during which they have the immediate right to withdraw their share of the contribution. The way this works in practice is that beneficiaries understand that if they exercise this right, the life insurance premiums won’t get paid and they will no longer benefit from the life insurance policy.
4. Specific ILIT Benefits
Minimizing Estate Taxes and Facilitating Wealth Transfers
The primary reason many people use ILITs is to remove the death benefit of a policy from their gross estate value, reducing the asset base for estate tax calculations.
If any estate taxes are due, the proceeds of the life insurance policy may be used for paying some or all of these, or these funds could be used to reimburse your survivors for estate taxes paid.
Avoiding Gift Taxation
ILITs help avoid gift taxation through the strategic use of annual gift tax exclusions to fund premium payments. In 2025, the annual gift tax exclusion is $18,000 per donor, per recipient. This means you can gift up to $18,000 to as many individuals or entities as you want, free of federal gift taxesโand if you are married, you and your spouse together can gift up to $36,000 gift-tax free.
Providing Liquidity for Survivors
A key reason for ILITs is to provide liquidity for your estate, as well as for other named individuals, such as a surviving spouse.
In this case, a surviving spouse may require funds for paying off debt and/or replacing lost income (such as from Social Security or a pension) so they will not have to alter their lifestyle during an already difficult time.
Protecting Government Benefits
If you have a special needs child or other dependent who receives financial assistance through government programs like SSI (Supplemental Security Income) or Medicaid, receiving a large inheritance could render them ineligible for these benefits.
The proceeds from a life insurance policy owned by an ILIT could help protect these benefits, provided the trustee properly controls how distributions are used.
Asset Protection from Creditors
While states have differing rules regarding how much of a life insurance policy’s death benefit and cash value are protected from creditors, any coverage held in an ILIT will typically be protected from creditors of both the trust grantor and the beneficiaries.
Controlling Distribution
The trustee of an ILIT can be given discretionary powers for making distributions, ensuring assets are not squandered by a “spend thrift” beneficiary or available to unintended recipients, such as a beneficiary’s ex-spouse.
The trustee may also control when the proceeds are paid outโimmediately or over a certain period. As the grantor, you could specify exactly when and how beneficiaries receive their distributions.
Creating a Multi-Generational Legacy
Because the life insurance proceeds are not included in the grantor’s estate, multiple generations of a familyโchildren, grandchildren, great-grandchildren, and beyondโcould benefit from the trust’s assets.
5. Addressing Common Questions
Are ILITs Obsolete Now that the Federal Estate Tax Exemption is Increased?
No, ILITs remain valuable planning tools for three key reasons:
- Asset Protection: ILITs continue to protect assets from creditors and lawsuits, regardless of estate tax considerations.
- Likelihood of Future Tax Changes: The estate tax exemption has a scheduled sunset at the end of 2025, reducing to approximately $7 million. Additionally, tax laws have historically changed frequently, making long-term planning prudent.
- Good Planning for Future Generations: Holding assets in an ILIT provides structure for future generations and can be an educational tool about investing, planning, and long-term growth.
Should I Use an ILIT?
An ILIT could be a viable solution if you:
- May have an estate tax issue upon your (or your spouse’s) passing
- Want to ensure that a special needs loved one will be taken care of financially while continuing to receive government benefits
- Would like to leave a legacy for future generations
- Want more control over which assets go where and when they are distributed
- Aim to reduce taxation so beneficiaries receive more in net proceeds
How Do Recent Legal Developments Impact ILITs?
The Estate of Becker case (2024) upheld ILIT validity against IRS “step transaction” challenges. Critical factors included:
- No retained ownership/control by the grantor
- Independent trustees
- No premium payment borrowing
The three-year rule remains in effect: policies transferred within 3 years of death remain in the taxable estate.
How Do ILITs Interact with Other Financial Planning Tools?
ILITs can complement other planning strategies:
| Partner Trust/Strategy | ILIT Integration Benefit |
|---|---|
| SLAT (Spousal Lifetime Access Trust) | Preserves spousal access to cash value |
| GRAT (Grantor Retained Annuity Trust) | Funds premium payments via annuity |
| Dynasty Trust | Multi-generational GST protection |
| Charitable Trust | Can replace assets given to charity |
6. Practical Implementation Guidance
Choosing a Life Insurance Company
When selecting a life insurance policy for an ILIT, consider the type of insurance company:
Stock Insurance Companies:
- Owned by shareholders
- Goal of making profit for investors
- Policyholders have little say in how the business is run
- Policyholders don’t receive a share of company profits
Mutual Insurance Companies:
- Owned by policyholders
- Managed for the benefit of policyholders
- Policyholders have voting rights for board of directors
- May pay dividends to policyholders (though not guaranteed)
Some mutual insurance companies have paid dividends consistently for more than a century, which can be taken as cash, added to policy cash value, or used to purchase additional coverage.
ILIT Administration Best Practices
- Crummey Notices: Provide 30-45 day withdrawal windows annually
- Accounting: Maintain separate ledgers for premium payments/gifts
- Policy Review: Conduct annual illustration updates for permanent policies
- Trust Synergies: Consider how the ILIT interacts with other estate planning vehicles
Business Succession Planning with ILITs
If you own a business, an ILIT can provide means to transfer it to loved ones while protecting it from large tax liabilities. The ILIT is particularly beneficial if the company’s value has grown since you implemented your initial business succession plan.
The “gap” between what the company was worth when you planned your estate and its value at your passing can be managed, along with various liquidity issues, through an ILIT.
If properly structured, life insurance benefits will not pass through probate, making funds immediately accessible to beneficiaries for estate taxes and other needs. This is crucial because estate taxes are due within 9 months of the owner’s death.
Similarly, assets used to fund the trust can bypass probate, and the trust can avoid taxes and creditor claims.
7. Conclusion
Irrevocable Life Insurance Trusts remain powerful estate planning tools in 2025, especially with the looming reduction in estate tax exemptions in 2026. While not appropriate for everyone, ILITs offer significant benefits for those with potential estate tax exposure, special needs dependents, succession planning needs, or those seeking to create a lasting legacy.
The flexibility and protection offered by ILITs extend beyond tax considerations, making them valuable components of comprehensive estate plans regardless of potential tax law changes. By working with experienced estate planning professionals, you can determine if an ILIT aligns with your goals and implement one effectively to protect your legacy and loved ones.
Remember, all situations are different. Consult with an estate planning attorney to determine if an ILIT is right for your specific circumstances.
