What Is an ILIT and How Does It Work?
An ILIT is a trust that owns a life insurance policy on your life. You create the trust, name a trustee, and transfer an existing policy or have the trust buy a new one. Because the trust is irrevocable, you give up control over the policy and the trust terms.
When you die, the death benefit goes to the trust, not to your estate. The trustee manages the money according to the trust document, often paying income to your beneficiaries or holding funds for specific purposes. The key benefit is that the death benefit is not included in your taxable estate, so it may avoid estate taxes.
To keep the policy out of your estate, you must not have any 'incidents of ownership'—like the right to change beneficiaries, borrow against the policy, or cancel it. The trustee holds those powers instead.
- The trust must be irrevocable; you cannot change or revoke it.
- You transfer an existing policy or fund a new one through gifts to the trust.
- The trustee owns the policy and controls distributions to beneficiaries.
- The death benefit goes to the trust, not to your estate, avoiding probate and estate taxes.
ILIT vs. Revocable Living Trust: Key Differences
A revocable living trust lets you keep control and change terms anytime. But because you keep control, the assets in it are still part of your taxable estate. An ILIT gives up control to remove the life insurance proceeds from your estate.
Revocable trusts are mainly for avoiding probate and managing assets during incapacity. ILITs are specifically for estate tax reduction and creditor protection. They serve different purposes, and you might use both in a comprehensive plan.
If your estate is below the federal estate tax exemption (which is high for most people), an ILIT may not be necessary. But state estate taxes and other factors can change that, so it's worth reviewing your situation.
- Revocable trust: you control and can change it; assets count in your estate.
- ILIT: you give up control; life insurance proceeds are outside your estate.
- Revocable trust avoids probate; ILIT avoids estate taxes and provides creditor protection.
- You can have both: a revocable trust for your home and investments, and an ILIT for your life insurance.
Benefits of an ILIT
The main benefit is estate tax savings. If your estate is large enough to owe federal or state estate taxes, an ILIT can keep the death benefit out of your taxable estate, saving your family a significant amount.
An ILIT also provides creditor protection. Since the trust owns the policy, your creditors and even your beneficiaries' creditors generally cannot reach the death benefit while it's in the trust. This can be valuable if you have a high-risk profession or a beneficiary with debt issues.
ILITs can also help control how the death benefit is used. You can set up spendthrift provisions, stagger distributions, or provide for minor children or a spouse with special needs. This ensures the money is managed according to your wishes after you're gone.
- Removes life insurance from your taxable estate, potentially saving estate taxes.
- Protects the death benefit from creditors and lawsuits.
- Allows you to dictate distribution terms over time, not just a lump sum.
- Can provide for beneficiaries who are minors, have special needs, or are not good with money.
Drawbacks and Considerations
The biggest drawback is loss of control. Once you create an ILIT, you cannot change the beneficiaries, the trustee, or the terms. If your family situation changes—like a divorce or a falling out—you're stuck with the original terms.
There are also costs. Setting up an ILIT typically requires a lawyer, and ongoing trustee fees and tax filings (like annual gift tax returns) add up. You also need to fund the trust with gifts to pay premiums, which may trigger gift taxes if they exceed the annual exclusion amount.
Another issue is the three-year rule. If you transfer an existing policy to an ILIT and die within three years, the death benefit is pulled back into your estate. To avoid this, you can have the trust buy a new policy, but that may mean higher premiums if your health has declined.
- Irrevocable means you can't adapt to changes in your life or family.
- Legal and administrative costs can be significant.
- Gifts to pay premiums may have gift tax implications.
- Existing policies are subject to a three-year look-back period for estate tax purposes.
How to Set Up an ILIT
Setting up an ILIT is not a do-it-yourself project. You'll need an experienced estate planning attorney to draft the trust document and ensure it complies with state law and tax rules. The attorney will also help you choose a trustee and decide on distribution terms.
You'll need to decide on a trustee—someone you trust to manage the policy and later the death benefit. It can be a family member, a friend, or a professional like a bank or trust company. Professional trustees charge fees but offer expertise and impartiality.
After the trust is created, you must transfer ownership of the policy or have the trust apply for a new one. You'll also need to notify your insurance company and change the beneficiary to the trust. Finally, you must make gifts to the trust to cover premiums, and the trustee must send formal notices to beneficiaries (Crummey powers) to keep those gifts eligible for the annual gift tax exclusion.
- Hire an estate planning attorney to draft the ILIT.
- Choose a trustee: individual or professional.
- Transfer an existing policy or have the trust buy a new one.
- Fund the trust with gifts for premiums and send Crummey notices to beneficiaries.
Is an ILIT Right for You?
An ILIT makes sense if you have a life insurance policy and your estate is likely to owe estate taxes. That's rare for most people because the federal exemption is high, but state taxes can apply at lower levels. If your estate is under the exemption, an ILIT may be overkill.
Even if estate taxes aren't a concern, an ILIT can still be useful for creditor protection or to control how the money is used. But you should weigh the loss of control and the costs. For many, a simpler approach—like naming a beneficiary directly or using a revocable trust—may be enough.
Talk to an estate planning attorney who can run the numbers and help you decide. They can also coordinate an ILIT with other estate planning tools, like a revocable living trust, to create a cohesive plan.
- Consider an ILIT if your estate exceeds the estate tax exemption.
- Use it for creditor protection if you face lawsuits or have beneficiaries with debt.
- If you want flexibility, an ILIT may not be the best fit.
- Consult an attorney to evaluate your specific situation.
Sources & references
For further reading, see these general legal resources from the Cornell Legal Information Institute.
External links open in a new tab. These sources are provided for general information only and are not legal advice.