Irrevocable Life Insurance Trust (ILIT): How It Works and When It Makes Sense

How an ILIT works, step by step

1. An attorney drafts the trust. You sign an irrevocable trust naming a trustee and beneficiaries, and the trust gets its own tax ID.
2. The trust buys the policy. The trustee applies for insurance on your life, with the trust as owner and beneficiary. Married couples often use a second-to-die (survivorship) policy, because estate tax is usually due at the second death.
3. You fund the premiums with gifts. You give cash to the trust each year, and the trustee pays the premium.
4. Beneficiaries get Crummey notices. Each gift gives beneficiaries a short window to withdraw it, which lets the gift qualify for the $19,000-per-beneficiary annual exclusion in 2026. They normally let the window lapse.
5. At death, the trustee collects the benefit and uses it under the trust’s terms: lending to or buying assets from the estate to provide cash for taxes, supporting a surviving spouse, or holding money for children over time.

Benefits and drawbacks of an ILIT

A worked example

A married couple in their late 60s has an estate of $40 million, including a family business and real estate. Their combined federal exemption in 2026 is $30 million, so about $10 million would be taxable at the second death. They want their three children to inherit the business without selling it to pay the tax.

Hypothetical and simplified; assumes the 2026 exemption, a flat 40% rate above it, and no state estate tax. The exemption is indexed for inflation in later years.

Owned personally, the policy would add $2 million of estate tax, taking much of its own benefit. Inside the ILIT, the full $5 million is available to provide cash for the $4 million bill, so the business does not have to be sold. With two parents and three children, the couple can give up to $114,000 a year to the trust within the 2026 annual exclusions to cover premiums.

Do you still need an ILIT with a $15 million exemption?

The 2025 tax law set the federal estate tax exemption at $15 million per person for 2026, or $30 million for a married couple, indexed for inflation and with no scheduled sunset. That takes many families out of the estate tax entirely, and some older ILITs set up when the exemption was much lower may no longer be needed for tax reasons. Before letting one go, it is worth checking four things:

• Growth. Hypothetically, a $12 million estate growing at 6% a year would double in about 12 years; actual growth will vary. The policy is often meant for the estate you will have, not the one you have now.
• Law changes. “No sunset” means the current law has no end date, not that Congress can’t lower the exemption later.
• State taxes. Several states, including New York, Massachusetts, and Maryland, have their own estate tax with much lower thresholds. Pennsylvania does not tax life insurance proceeds, but if you live in, or own real estate in, another state, that state’s estate or inheritance tax may apply.
• Non-tax reasons. Control, creditor protection, blended-family planning, and cash for an illiquid estate still apply at any estate size.

If an existing ILIT no longer fits, an estate attorney may be able to change it through decanting, a trust protector, or state-law modification, and the trustee can review whether the policy itself still makes sense. See our 2026 estate tax exemption guide.

When an ILIT makes sense, and when it doesn’t

Moving a policy you already own into an ILIT

Buying a new policy inside the trust is the cleanest route. When health or cost makes that impractical, there are two ways to move an existing policy:

The sale route relies on the trust being treated as wholly owned by you for income tax purposes. Revenue Ruling 2007-13 holds that a transfer to such a trust is treated as a transfer to the insured, so the transfer-for-value rule does not apply. Your attorney may need to add a provision, such as a power to swap assets, to get that status. The sale also needs an independent valuation of the policy.

How an ILIT is taxed

• The death benefit. Generally free of federal income tax for the trust and its beneficiaries, as with any life insurance paid by reason of death.
• Income tax while you are alive. Most ILITs are grantor trusts, because trust income can be used to pay premiums on your life. Any income, often little or none, is reported on your own return, and the trust may not need to file its own Form 1041. Your CPA and attorney should confirm how yours is treated.
• After your death. The trust usually becomes a separate taxpayer. Investment income kept in the trust is taxed at trust rates, which reach the top bracket at a much lower income than for individuals, so distributions and investments should be planned with that in mind.
• Gift tax. Premium gifts qualify for the annual exclusion when Crummey powers are used correctly. Larger gifts use lifetime exemption and are reported on Form 709.
• Generation-skipping transfer tax. If grandchildren may benefit, allocating GST exemption ($15 million in 2026) to every premium gift, including annual exclusion gifts, keeps the trust’s GST inclusion ratio at zero, so the death benefit can pass free of GST tax. That is why many ILITs are written to last for several generations where state law allows.

Paying larger premiums

Annual exclusion gifts don’t always cover the premium on a large policy. Common ways to fill the gap:

• Lifetime exemption gifts. A larger one-time gift to the trust, sometimes enough to prepay premiums for years, using part of your $15 million exemption.
• Private split-dollar arrangements. You advance the premiums and are repaid from the death benefit or cash value, which can reduce the gift each year. These need careful documentation and an exit plan, and the amount owed back to you stays in your estate.
• Premium financing. The trust borrows from a lender to pay premiums. It can work for very large policies, but it adds interest-rate, collateral, and policy-performance risk, including having to post more collateral or being unable to repay, that should be stress-tested before you commit.

Choosing the trustee and beneficiaries

• Trustee. Not you, the insured. Families often choose an adult child, a sibling, a trusted friend, or a professional trustee. The trustee pays premiums, sends Crummey notices, keeps records, and manages the proceeds after death.
• Your spouse as a beneficiary. Common, and it lets the proceeds support your spouse without being included in their estate later, as long as your spouse does not contribute to the trust (gifts should come from your own funds, not a joint account) and holds only limited powers. Your spouse can sometimes serve as trustee if distributions are limited to health, education, maintenance, and support; your attorney will set that standard.
• Flexibility. Many newer ILITs name a trust protector who can make limited changes, such as updating administrative terms or moving the trust to another state, without you holding powers that would pull the policy back into your estate.

What happens when the insured dies

1. The trustee files the death claim with the insurer and deposits the proceeds in the trust account.
2. If the estate needs cash for taxes or debts, the trustee can lend to the estate or buy assets from it at fair value. The trust can permit, but must not require, the trustee to pay the estate’s taxes or debts; a binding obligation pulls those proceeds back into the estate to that extent.
3. The trustee invests and distributes the money under the trust’s terms: outright, in stages, or held for life for each beneficiary.
4. The trust gets its own tax filings going, typically a Form 1041 for each year with $600 or more of gross income.

Common ILIT mistakes

• Paying premiums directly to the insurer instead of gifting to the trust first.
• Skipping or backdating Crummey notices.
• Naming yourself, your estate, or a revocable trust as owner or beneficiary of the policy.
• Keeping powers over the policy, such as the right to change beneficiaries or borrow against it.
• Never reviewing the policy, so a universal life policy quietly heads toward lapse.

Costs and ongoing administration

• Legal fees to draft the trust, plus any later amendments allowed under state law.
• Annual administration: a trust bank account, Crummey notices for each gift, premium payments, and records the trustee should keep.
• Gift tax returns (Form 709) when gifts exceed the annual exclusion or when you allocate generation-skipping transfer tax exemption to the trust.
• The insurance itself. Premiums depend on age, health, policy type, and guarantees. Compare guaranteed and non-guaranteed illustrations, not just the premium.

An ILIT is only as good as its administration. Missed Crummey notices or premiums paid directly by the insured can weaken the plan.

Pennsylvania families

Life insurance proceeds are generally exempt from Pennsylvania inheritance tax even without a trust. Because policies already escape the state tax, the reasons to use an ILIT in Pennsylvania are the federal estate tax, control of the proceeds, and protecting beneficiaries. Proceeds can also give heirs the cash to pay Pennsylvania inheritance tax on other assets within three months and capture the 5% discount.

How Rubiq helps

We are not a law firm and do not draft trusts. We model your estate tax exposure, review existing policies and ownership, coordinate with your estate attorney and CPA, and help the trustee keep the premium and gift schedule on track. When a review shows a need for coverage, our advisors can help you obtain it through LPL Financial and may earn a commission if you buy a policy through them; any compensation is disclosed before you decide, and you are free to buy coverage from any agent you choose. See our insurance review and estate planning pages, and our guides to revocable vs. irrevocable trusts and the gift tax.

Frequently asked questions