Irrevocable Life Insurance Trust (ILIT)
An Irrevocable Life Insurance Trust (ILIT) is a trust that owns a life insurance policy on the grantor's life, structured so that the policy proceeds are excluded from the grantor's taxable estate at death while remaining available to provide liquidity to heirs or to pay estate taxes.
Life insurance proceeds paid directly to an individual are generally income-tax-free, but they are included in the insured's taxable estate if the insured held any incidents of ownership in the policy at death. For large estates, this inclusion can result in a significant portion of the death benefit being subject to federal estate tax. The ILIT removes this problem by having the trust — rather than the insured — own the policy from inception.
For the ILIT to work as intended, the insured must not retain any incidents of ownership in the policy. This means the insured cannot have the right to change beneficiaries, borrow against the policy, or surrender it. The trust, governed by an independent trustee, holds all of these rights. Premiums are typically funded by annual gifts from the grantor to the trust, which the trustee uses to pay premiums after providing beneficiaries with a Crummey notice — a temporary withdrawal right that qualifies the gift for the annual gift tax exclusion.
If the insured dies within three years of transferring an existing policy to the ILIT, the three-year look-back rule causes the proceeds to be pulled back into the taxable estate. For this reason, many estate planners recommend having the ILIT apply for and own the policy from the outset rather than having the grantor purchase the policy and transfer it later.
At death, the insurance proceeds flow into the trust rather than directly to the estate. The trustee can then loan funds to the estate or purchase assets from the estate, providing the liquidity needed to pay estate taxes without forcing heirs to sell illiquid assets such as a family business or real estate.
The ILIT is one of the most widely used estate planning vehicles for high-net-worth families, and it must be drafted carefully to comply with IRS requirements and to reflect the grantor's distribution objectives for the trust beneficiaries.