Irrevocable Life Insurance Trust ILIT

Why an ILIT Exists

When someone dies owning a life insurance policy, the full death benefit is included in their taxable estate. For estates approaching the federal exemption threshold — $15 million per individual in 2026 — that inclusion can trigger estate tax on the taxable amount above the exclusion, at rates up to 40%.

An Irrevocable Life Insurance Trust can remove the policy from the insured's gross estate when properly structured. The trust, not the individual, owns the policy. When the insured dies, the death benefit passes to trust beneficiaries outside probate and, if the insured retained no incidents of ownership and the policy was not transferred within three years of death, outside the taxable estate. The trust can also protect proceeds from beneficiaries' creditors.

The trade-off is in the name: irrevocable. Once the trust is funded, the grantor gives up control. They cannot change beneficiaries, borrow against the policy, or cancel it. The trustee manages those decisions.

The Three-Year Transfer Rule

This is where most ILIT mistakes happen. Under IRC § 2035, if you transfer an existing policy into an ILIT and die within three years of the transfer date, the entire death benefit is pulled back into your gross estate — exactly as if the trust didn't exist.

The IRS applies this rule strictly. The lookback runs from the completed ownership transfer, not the date the trust was created or the date you decided to make the transfer.

The standard workaround is to have the ILIT trustee apply for a brand-new policy from the start. The trust is the original owner and original applicant. The grantor gifts cash to the trust, and the trustee uses that cash to pay the premiums. Because the grantor never owned the policy, the three-year lookback never applies.

If you're working with an existing policy, transferring it is still viable — but you need to survive three years from the transfer date. For someone in good health, that's usually a reasonable bet. For someone with a terminal diagnosis, it defeats the purpose.

Crummey Powers and Gift Tax

When the grantor gifts cash to the ILIT to cover premium payments, the IRS classifies that transfer as a gift. Gifts of "future interests" — money the beneficiaries can't touch yet — don't qualify for the annual gift tax exclusion ($18,000 per recipient in 2024).

A Crummey power solves this. Named after the taxpayer in Crummey v. Commissioner, it gives each trust beneficiary a temporary window (typically 30 to 60 days) to withdraw their proportional share of the gifted funds. The withdrawal right converts the gift from a future interest into a present interest, which qualifies for the exclusion.

In practice, beneficiaries almost never exercise the withdrawal right — doing so would deplete the trust and defeat its purpose. But the right must be real, not illusory. The trustee must send written Crummey notices to each beneficiary documenting the contribution amount, the withdrawal window, and how to exercise the right. Without those notices, the IRS can disallow the exclusion.

UK Equivalent: Writing a Policy "In Trust"

The UK doesn't use ILITs as such, but the principle is similar. Placing a life insurance policy "in trust" can keep the death benefit outside the deceased's estate for Inheritance Tax purposes; the trust type and premium gifts can still affect IHT.

A policy written in trust also bypasses probate, releasing funds to beneficiaries immediately — often within days rather than the months a probated estate requires. For families who need the death benefit to pay the estate's own IHT bill, this timing difference can prevent forced asset sales.

The seven-year rule applies to potentially exempt transfers (PETs), generally gifts to individuals and certain bare trusts; gifts may be exempt under the £3,000 annual exemption or other rules. Transfers into most discretionary trusts are instead immediately chargeable lifetime transfers and can also face 10-year and exit charges. Placing the policy in trust from the outset avoids a later assignment of an existing policy, but premium gifts and trust charges still need to be considered.

Who Actually Needs an ILIT

For estates well below the federal exemption, an ILIT adds complexity without meaningful tax savings. The trust requires a separate EIN, annual filings, a competent trustee, and ongoing Crummey notice administration. Attorney setup costs typically run $2,000 to $5,000, plus ongoing trustee fees.

An ILIT makes sense when the estate, including the death benefit, is approaching or exceeding the $15 million federal exclusion for 2026. It also makes sense for business owners whose life insurance funds a buy-sell agreement, since those proceeds would otherwise inflate the taxable estate.

For a structured approach to claiming life insurance proceeds — whether from an individually owned policy, a trust-owned policy, or an employer group plan — the Life Insurance Claims Toolkit walks through each scenario with document checklists and deadline trackers.