Irrevocable Life Insurance Trusts (ILITs): How They Work

How a properly structured ILIT can keep life insurance proceeds outside a taxable estate.

June 13, 2026

Life insurance is usually bought for a simple reason: someone would need cash if the insured died. The complication is that for wealthy families, the cash itself can create an estate-planning problem. A large policy that is owned personally may increase the value of the insured's gross estate, and the federal estate tax rate reaches 40% on taxable amounts above the highest bracket.^1,2

That is where an irrevocable life insurance trust, usually shortened to ILIT, enters the conversation. The goal is not to make life insurance more complicated. The goal is to separate the insurance benefit from the insured's taxable estate while still letting the trust use the death benefit for the people and purposes the family cares about.

This topic matters in 2026 because the estate-tax backdrop is unusually favorable but still relevant. The IRS lists a $15,000,000 federal estate-tax filing threshold for decedents dying in 2026. Married couples may also use portability if the first spouse's estate makes a timely election, which can preserve the deceased spouse's unused exclusion for the survivor.¹ That higher threshold means fewer families face federal estate tax today. It does not mean every family should ignore estate structure. Life insurance can be large, state estate and inheritance taxes can still matter, and families with business interests, second marriages, unequal heirs, or creditor concerns often care about more than just the federal number.

I view ILITs as a box with a lock and a set of instructions. The lock is the irrevocable trust structure. The instructions are the trust terms. The insurance is the asset inside the box. If the wrong person keeps the key, the IRS may still treat the death benefit as part of the estate. If the instructions are sloppy, the box may create family and administrative problems even if the tax result works.

An ILIT is an irrevocable trust designed to own one or more life insurance policies. The trust is usually the policy owner and beneficiary. The insured is typically the person whose life is covered, and the trust beneficiaries are usually a spouse, children, grandchildren, or other family members.

That ownership distinction is the core point. If the insured owns the policy personally, or if the proceeds are payable to the insured's estate, the death benefit can be included in the gross estate. Section 2042 includes life insurance proceeds receivable by the executor and also includes proceeds payable to other beneficiaries if the decedent held any "incidents of ownership" at death.³ Treasury regulations explain that incidents of ownership are not limited to technical legal title. They include economic powers over the policy, such as the power to change the beneficiary, surrender or cancel the policy, assign it, pledge it for a loan, or borrow against the cash value.³

An ILIT tries to remove those powers from the insured. The trustee, not the insured, owns and administers the policy. The trust document, not the insured's will, controls who benefits from the death benefit and how distributions are made.

That is why the word "irrevocable" matters. A revocable trust is usually ignored for this purpose because the grantor can change or unwind it. An ILIT is different. If the trust is properly drafted, funded, and administered, the insured should not be able to take the policy back, change the trust beneficiaries, borrow against the policy, or use the policy for personal purposes.

For context, the IRS estate-tax page defines the gross estate broadly. It can include cash, securities, real estate, insurance, trusts, annuities, business interests, and other assets.¹ In 2026, the filing threshold is $15,000,000 for a U.S. citizen or resident decedent, as shown in Figure 1. The same IRS page lists the threshold rising from $5,490,000 in 2017 to $11,180,000 in 2018 after the Tax Cuts and Jobs Act, and then to $15,000,000 for 2026 after the One Big Beautiful Bill Act changes reflected in IRS guidance.¹

The higher exemption is helpful. But life insurance can be large enough to change the answer. Imagine a business owner with a $13 million net estate and a $5 million personally owned life insurance policy. If that policy is included in the estate, the gross estate can move from below the 2026 federal filing threshold to above it. The actual tax result would depend on deductions, marital planning, debts, prior taxable gifts, portability, state law, and the estate's full facts, but the planning issue is clear: the death benefit is cash, and cash has estate-tax value.

ILIT planning is most powerful when the policy is large relative to the estate or when the estate is already expected to be taxable. A $2 million policy may be irrelevant for a family with a $5 million estate and no state estate-tax exposure. The same $2 million policy can be very relevant for a family whose estate is already over the exemption, whose assets are illiquid, or whose heirs need cash without forcing a business sale or real estate liquidation.

The takeaway: an ILIT is not about hiding life insurance. It is about deciding whether the policy should be owned by the insured, by a revocable structure, by a business, or by an irrevocable trust designed to keep the proceeds outside the taxable estate.

Figure 1: Federal estate-tax filing thresholds for decedents dying from 2017 through 2026.

The cleanest ILIT structure is usually created before the policy exists. The attorney drafts the ILIT, the trustee applies for and owns the policy, and the insured never personally owns the policy. That matters because Section 2035 can pull certain transferred interests back into the decedent's estate if the insured transferred the policy or relinquished a power over it during the three-year period ending on the date of death.⁴ A new policy purchased directly by the trust generally avoids that specific transfer problem because the insured did not first own the policy and then give it away.

After the trust is created, the premium funding becomes an annual process. The grantor gives cash to the ILIT. The trustee notifies the trust beneficiaries that they have a temporary withdrawal right over the contribution. If the beneficiaries do not exercise that right, the trustee uses the cash to pay the insurance premium.

That notice process is not paperwork theater. Gifts to a trust are often future-interest gifts, and future-interest gifts do not qualify for the annual gift-tax exclusion. Section 2503 excludes the first inflation-adjusted amount of gifts to each person only for gifts other than future interests. For 2026, that annual exclusion amount is $19,000 per donee, or $38,000 if two spouses each use an exclusion for the same donee.⁶ Crummey withdrawal powers are the common technique used to convert a trust contribution into a present-interest gift that can qualify for the annual exclusion. The name comes from the 1968 Crummey case, where the court allowed the claimed exclusions because the beneficiaries had an enforceable demand right over trust additions.⁷

Figure 2 shows why this matters in practice. A married couple with four beneficiaries could potentially fund $152,000 of annual premium gifts in 2026 using annual exclusions, assuming the withdrawal powers are properly drafted and administered. With six beneficiaries, the number is $228,000. That does not mean every family should design a policy to consume the full exclusion amount. It means the gift structure can be meaningful when the family has multiple beneficiaries and a genuine insurance need.

When the insured dies, the policy death benefit is paid to the ILIT. Life insurance proceeds paid because of the insured's death are generally not included in the beneficiary's gross income, although interest and transfer-for-value issues can create separate tax consequences.⁵ If the ILIT owns the policy and the insured retained no incidents of ownership, the death benefit may also be outside the insured's taxable estate under Section 2042.³ The trustee can then hold, invest, or distribute the proceeds according to the trust document.

That last phrase matters: according to the trust document. An ILIT can give heirs immediate access, staggered access, discretionary support, asset protection, or a lifetime trust structure. It can also be designed to provide liquidity to the estate, often through a loan or asset purchase, rather than making the policy legally payable to the estate or legally obligated to pay estate expenses. That drafting distinction is important because proceeds payable to or for the benefit of the estate can create estate inclusion.³

Figure 2: Potential 2026 annual-exclusion premium-funding capacity by number of ILIT beneficiaries.

The first use is estate-tax liquidity. Some families are asset rich and cash poor. They may own a closely held business, a farm, real estate, concentrated private investments, or other assets that are difficult to sell quickly. If estate tax, debts, equalization payments, or transition costs will be due after death, an ILIT can create liquidity without adding the policy proceeds to the taxable estate.

The second use is family equalization. A parent may want one child to inherit a business and another child to receive cash. The business may be valuable but illiquid. Life insurance owned by an ILIT can help equalize inheritances without forcing the operating asset to be divided or sold.

The third use is blended-family planning. A client may want to provide for a surviving spouse during life and ultimately benefit children from a prior marriage. An ILIT can define who receives income, who receives principal, and how remaining assets pass at the survivor's death. That does not eliminate the need for careful legal drafting, but it can make the family plan clearer.

The fourth use is creditor and spendthrift protection. An outright insurance payment to a beneficiary becomes that beneficiary's asset. Depending on state law and the beneficiary's facts, that can expose the money to divorces, lawsuits, creditors, poor spending decisions, or pressure from others. A trust can create guardrails. The beneficiary may benefit from the money without owning it outright.

The fifth use is wealth replacement. A family might use a charitable strategy, such as a charitable remainder trust, that eventually sends an asset to charity. An ILIT can own insurance intended to replace some or all of that value for heirs. The structure only makes sense when the charitable intent, insurance underwriting, premium cost, and estate plan all line up.

The sixth use is generation-skipping planning. If the ILIT is intended to benefit grandchildren or later descendants, generation-skipping transfer tax planning may be part of the design. The 2026 GST exemption is also $15,000,000 under IRS guidance, but allocation, automatic-allocation rules, and Form 709 reporting need to be handled carefully.^1,8

The headline advantage is potential estate-tax exclusion. If the ILIT is properly structured, the death benefit can pass outside the insured's taxable estate. For a taxable estate, that can be a material result because the federal transfer-tax rate reaches 40% at the top bracket.²

The second advantage is leverage. Premiums are paid over time, but the death benefit arrives as a larger lump sum at death. That leverage is the reason life insurance can be useful in estate planning. A properly structured ILIT can turn annual gifts into a future pool of liquidity that is generally income-tax-free to the trust beneficiary and potentially outside the insured's estate.⁵

The third advantage is control after death. A personally owned policy with individual beneficiaries usually pays outright. An ILIT can hold proceeds in trust, stagger distributions, support a spouse, protect children, provide for minors, preserve assets for a beneficiary with poor financial habits, or coordinate with special-needs planning where appropriate.

The fourth advantage is creditor and divorce protection. State law matters, and no trust should be sold as magic protection, but a discretionary trust can be more protective than an outright inheritance. This is often as important as the tax result.

The fifth advantage is liquidity without forced selling. A trustee can use the death benefit to help the estate or heirs buy time. In the right structure, the trust may lend money to the estate or buy estate assets, which can help the family pay expenses, taxes, or equalization obligations without dumping illiquid assets at a bad time. The documents need to be drafted so the trust is not simply obligated to pay the estate's liabilities in a way that creates estate inclusion.

The first trade-off is control. Once the ILIT is funded, the grantor should not think of the policy as a personal asset. The insured should not be changing beneficiaries, borrowing from the policy, pledging it, surrendering it, or directing the trustee as if nothing changed. Those are exactly the kinds of powers that can create incidents of ownership.³

The second trade-off is the three-year rule for existing policies. If an insured already owns a policy and transfers it to an ILIT, Section 2035 can include the proceeds in the estate if the insured dies within three years of the transfer.⁴ That does not mean every existing policy is unusable. It means the family needs to understand the risk and decide whether to transfer the old policy, have the trust buy a new one, or use another structure.

The third trade-off is administration. Someone has to serve as trustee. Someone has to open the trust account, receive contributions, send beneficiary withdrawal notices, track the notice period, pay premiums, keep records, and coordinate with the CPA. If the trustee ignores the process, the gift-tax treatment can be weakened and the trust can become hard to defend.

The fourth trade-off is gift tax complexity. The annual exclusion is powerful, but it is not automatic. The 2026 exclusion is $19,000 per donee, and it applies to present-interest gifts.⁶ Premium gifts that exceed available annual exclusions may use lifetime gift exemption and may require a gift tax return. Gifts to trusts, GST allocations, split gifts between spouses, and indirect skips are Form 709 issues, not casual year-end housekeeping.⁸

The fifth trade-off is premium commitment. A large policy is only useful if it stays in force. If premiums become unaffordable or the policy underperforms expectations, the family may have to reduce coverage, add funding, or accept a lapse. Permanent life insurance illustrations should be stress-tested. Term policies also need review because the coverage may expire before the planning need does.

The sixth trade-off is loss of flexibility. The ILIT may own cash value, but that cash value is no longer the insured's personal liquidity. If the insured later needs cash for retirement, health care, business needs, or family support, the ILIT may not be available. This is why I would never evaluate an ILIT without first looking at the broader balance sheet.

The seventh trade-off is trustee design. Naming the insured as trustee, giving the insured too much control, or letting the trustee act as a rubber stamp can create tax and fiduciary problems. The trustee should understand the job, the document, the notice process, and the boundaries.

I would start with the balance sheet, not the insurance illustration. How large is the taxable estate today? How large could it be in ten or twenty years? How much of it is illiquid? What debts, tax liabilities, charitable goals, family equalization needs, and business transition needs would exist at death? Who actually needs the money, and when?

Then I would ask whether the insurance need is real. ILITs are often described as tax tools, but the underlying asset is still life insurance. If the family does not need insurance, the trust does not fix that. If the family does need insurance, the next question is ownership. Should the policy be owned personally, by a revocable trust, by a business, by an ILIT, or by some other structure? The answer depends on estate tax, control, creditor protection, family design, and premium funding.

Next, I would coordinate the estate attorney, CPA, and insurance professional before anything is signed. The attorney drafts the ILIT and beneficiary provisions. The CPA helps with gift-tax reporting, GST allocation, and annual administration. The insurance professional designs and stress-tests the policy. Our role is to model the estate, evaluate liquidity needs, compare funding trade-offs, and make sure the policy and trust serve the plan rather than drive it.

I would also build an administration checklist before the first premium is paid. Who sends Crummey notices? How long is the withdrawal window? Where are copies stored? Who confirms the trustee, not the grantor, paid the premium? What happens if a beneficiary exercises a withdrawal right? Who reviews the policy annually? These are mundane questions, but they are exactly the questions that keep an ILIT from becoming a fragile document in a file cabinet.

ILITs are powerful when the facts fit. They can keep life insurance proceeds outside the taxable estate, create liquidity, protect beneficiaries, and give families more control over how a death benefit is used. They are also irrevocable, administrative, and unforgiving when handled casually.

The right question is not, "Should every wealthy family have an ILIT?" The right question is, "If life insurance is part of the plan, who should own it, who should control it, and what should happen to the proceeds after death?" Sometimes the answer is an ILIT. Sometimes it is a simpler ownership structure. The structure should follow the purpose.

This piece is educational. The specifics are a conversation with us, your estate attorney, your CPA, and the insurance professional before acting. Our team can help model the estate and liquidity trade-offs, but the trust document and tax reporting need to be coordinated carefully.

All my best,

Brandon VanLandingham, CFA, CMT, CFP

Founder / CIO

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[1] Internal Revenue Service, "Estate tax," page last reviewed December 22, 2025; and Internal Revenue Service, Rev. Proc. 2025-32. The IRS estate-tax page lists the 2026 filing threshold at $15,000,000 and describes portability for surviving spouses. Rev. Proc. 2025-32 states that Public Law 119-21 increased the basic exclusion amount to $15,000,000 for calendar year 2026 and that the 2026 GST exemption amount is $15,000,000. https://www.irs.gov/businesses/small-businesses-self-employed/estate-tax and https://www.irs.gov/pub/irs-drop/rp-25-32.pdf

[2] 26 U.S.C. Section 2001, Cornell Law School Legal Information Institute. Section 2001 imposes the estate tax and includes the federal estate-tax rate schedule, with the top bracket at 40% for amounts over $1,000,000 in the tentative tax base. https://www.law.cornell.edu/uscode/text/26/2001

[3] 26 U.S.C. Section 2042 and Treasury Regulation Section 20.2042-1, Cornell Law School Legal Information Institute. These authorities describe when life insurance proceeds are included in the gross estate and define incidents of ownership, including powers to change beneficiaries, surrender or cancel a policy, assign it, pledge it, or borrow against cash value. https://www.law.cornell.edu/uscode/text/26/2042 and https://www.law.cornell.edu/cfr/text/26/20.2042-1

[4] 26 U.S.C. Section 2035, Cornell Law School Legal Information Institute. Section 2035 includes certain transferred interests or relinquished powers in the gross estate if transferred within the three-year period ending on the date of death and if the property would have been included under Sections 2036, 2037, 2038, or 2042 had the interest or power been retained. https://www.law.cornell.edu/uscode/text/26/2035

[5] Internal Revenue Service, "Life Insurance & Disability Insurance Proceeds," page last reviewed October 10, 2025; and 26 U.S.C. Section 101. The IRS states that life insurance proceeds received as a beneficiary due to the death of the insured generally are not includable in gross income, though interest and transfer-for-value issues can create taxable amounts. https://www.irs.gov/faqs/interest-dividends-other-types-of-income/life-insurance-disability-insurance-proceeds/life-insurance-disability-insurance-proceeds and https://www.law.cornell.edu/uscode/text/26/101

[6] Internal Revenue Service, "Frequently asked questions on gift taxes," updated December 2025; Internal Revenue Service, Rev. Proc. 2025-32; and 26 U.S.C. Section 2503. The IRS gift-tax FAQ lists the 2026 annual exclusion at $19,000 per donee and $38,000 per donee from two spouses. Rev. Proc. 2025-32 states that the first $19,000 of gifts to any person, other than gifts of future interests, are not included in taxable gifts for 2026. Section 2503 provides the statutory present-interest framework. https://www.irs.gov/businesses/small-businesses-self-employed/frequently-asked-questions-on-gift-taxes, https://www.irs.gov/pub/irs-drop/rp-25-32.pdf, and https://www.law.cornell.edu/uscode/text/26/2503

[7] Crummey v. Commissioner, 397 F.2d 82 (9th Cir. 1968), OpenJurist. The court allowed the claimed annual exclusions where beneficiaries had enforceable demand rights over trust additions. https://openjurist.org/397/f2d/82/crummey-v-commissioner-of-internal-revenue

[8] Internal Revenue Service, "Instructions for Form 709 (2025)." The instructions address gift splitting, gifts to trusts, direct and indirect skips, GST allocations, and supplemental documents for gift-tax reporting. https://www.irs.gov/instructions/i709

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