The Irrevocable Life Insurance Trust, and Why It Still Matters at a $15 Million Exemption
Life insurance you own is part of your taxable estate. An ILIT keeps the death benefit out, supplies liquidity when it is needed and adds protection the policy alone does not have. The three year rule and the premium gifts are where the mistakes happen.
People are often surprised to learn that life insurance is taxed at death. The proceeds are income tax free to the beneficiary, but if the insured owned the policy, or held what the Code calls incidents of ownership, the full death benefit is included in the insured's gross estate.1 With the federal estate tax rate at 40 percent above the exemption, a $5 million policy owned the wrong way can cost a family $2 million.2
The basic exclusion amount is $15 million per person in 2026, so fewer families face federal tax than a decade ago.3 The irrevocable life insurance trust still matters for three groups: families above the exemption, families in the roughly one third of states, plus the District of Columbia, that impose their own estate or inheritance tax at much lower thresholds, and families who want the protection and control that a trust supplies even when tax is not the issue.
How an ILIT works
- The insured creates an irrevocable trust and names an independent trustee. The insured cannot be the trustee and should hold no power to change beneficiaries, borrow against the policy or surrender it.
- The trust applies for and owns the policy from the start, or an existing policy is transferred to it.
- The insured makes annual gifts to the trust, and the trustee pays the premiums.
- At death the trust collects the proceeds free of estate tax and either holds them for the beneficiaries under the terms the insured chose or uses them to buy assets from, or lend to, the estate so that the estate has cash to pay taxes and expenses without selling the business or the real estate.4
The three year rule
If the insured transfers an existing policy to the trust and dies within three years, the proceeds are pulled back into the estate.5 That is why the usual advice is to have the trustee apply for a new policy in the trust's name. Where an existing policy has to be used, the trust can purchase it from the insured for its fair market value rather than receive it by gift, which takes the transfer outside the three year rule, though the transfer for value rules then require care so that the proceeds stay income tax free.6
The premium gifts
Each year's premium contribution is a gift to the trust. The annual exclusion, $19,000 per donee in 2026, is available only for gifts of a present interest, and a gift to a trust is ordinarily a future interest.7 The fix is a Crummey power: each beneficiary receives written notice of the contribution and a limited window, often thirty days, to withdraw his share. The power is rarely exercised, but its existence makes the gift a present interest.8 Trustees who skip the notices, or beneficiaries who sign them a year late, put the exclusion at risk. Larger premiums can be covered by applying lifetime exemption, which is reported on a gift tax return.
What the trust adds beyond tax
- Liquidity. Proceeds arrive within weeks and can be used to pay estate tax, which is due nine months after death, without a forced sale.
- Control. The insured decides in the document how and when the money reaches a spouse, a child or a grandchild. A twenty five year old does not receive $5 million outright.
- Protection. Assets in a properly drafted irrevocable trust with a spendthrift clause are generally beyond the reach of a beneficiary's creditors and a beneficiary's divorcing spouse.
- Generation skipping. GST exemption allocated to the premium gifts leverages into a death benefit many times larger, all of it exempt.
The trust is irrevocable, which means the insured cannot change the beneficiaries later. Good drafting handles that with a trust protector, a power of appointment in the surviving spouse, or decanting authority under state law. The decision that cannot be undone is who owns the policy, and that is the decision to get right first.
Notes
- IRC sections 101(a), 2042. ↩
- IRC section 2001(c). ↩
- Rev. Proc. 2025-32. ↩
- Treas. Reg. section 20.2042-1(b)(1); proceeds are included only if the trustee is legally obligated to pay estate taxes or debts, so the trust may be authorized, but not required, to buy assets from or lend to the estate. ↩
- IRC section 2035(a). ↩
- IRC section 101(a)(2); Treas. Reg. section 1.101-1(b). A sale to a grantor trust is generally treated as a sale to the insured and falls within the exception in section 101(a)(2)(B). See Rev. Rul. 2007-13, 2007-11 I.R.B. 684. ↩
- IRC section 2503(b); Treas. Reg. section 25.2503-3. ↩
- Crummey v. Commissioner, 397 F.2d 82 (9th Cir. 1968); Estate of Cristofani v. Commissioner, 97 T.C. 74 (1991). ↩
Terry L. (T. L.) Turnipseed, J.D., LL.M., CTFA, is a tax, trust and estate attorney in Fort Lauderdale, Florida, and Head of Estate and Tax Planning at Alta Trust Company. He is a former tenured professor of law at Syracuse University. Reach him at tl@turnipseed.law or on LinkedIn. This article is general information, not legal advice.