Trust Law/Level V · Tax and legacy/5.1 Estate and gift tax/Lesson 4
Life-insurance trusts (ILIT)
How an irrevocable life insurance trust can keep policy proceeds out of the insured’s US taxable estate, and why fewer families need one today.
Education, not legal advice. Trust law changes from country to country and state to state, and the right structure depends on your situation. Anything you sign should be drafted or reviewed by a qualified lawyer where you live.
The lean path
The cheapest, lowest-tax, simplest and most private route the law allows, best first. Each step names the rule it rests on and the condition that keeps it lawful.
- Below the 2026 basic exclusion of $15,000,000, skip the trust: naming individuals as beneficiaries keeps proceeds free of federal income tax (IRC §101) and out of probate, and §2042 inclusion costs nothing; check state estate tax, which starts at $1,000,000 in Oregon.
- Naming a US-citizen spouse as beneficiary qualifies for the unlimited marital deduction, so §2042 inclusion brings no federal estate tax at the first death; the catch is that unspent proceeds then sit in the survivor’s estate unless sheltered by the survivor’s own or ported exclusion.
- An adult child can buy and own a policy on a parent directly, keeping proceeds out of the parent’s estate with no trust drafting; the catch is that the policy then belongs to the child and is exposed to the child’s creditors and estate.
- When a trust is warranted, have the ILIT apply for and buy a new policy with its own funds, so the 3-year rule of IRC §2035 never starts; an existing policy transferred in stays taxable if the insured dies within 3 years.
- Fund premiums with annual-exclusion gifts of up to $19,000 per beneficiary in 2026 using Crummey withdrawal rights and written notices; the insured must hold no incidents of ownership, even as trustee, and gifts above the exclusion go on Form 709.
MaterialsA copy of any life insurance policy you are reading about, showing its owner and beneficiaryThe IRS instructions for Form 709, the gift tax returnLesson 5.1.2, on the annual exclusion and Crummey powersYour state’s tax agency page on estate or inheritance tax, if your state has one
Wonder
- Why are life insurance proceeds counted in an estate at all?
- What happens if an existing policy is given to a trust and the insured dies soon after?
- With today’s high federal exclusion, who still uses an ILIT?
Explore
- Life insurance paid because of death is generally free of federal income tax (IRC §101), but it can still be subject to estate tax. Under IRC §2042, the insured’s gross estate includes proceeds payable to the executor, and proceeds payable to anyone else if the insured held any ‘incidents of ownership’ in the policy at death. Treasury regulations list examples: the power to change the beneficiary, surrender or cancel the policy, assign it, pledge it for a loan or borrow against it.
- An irrevocable life insurance trust (ILIT) is a trust that owns a policy on the insured’s life and is named as its beneficiary. If the insured holds no incidents of ownership and the proceeds are not payable to the estate, they are generally not in the insured’s gross estate. A trust the insured could revoke would not work, because the insured would keep control. The regulations also treat a power to change beneficial ownership as an incident of ownership even if the insured holds it as trustee.
- IRC §2035 adds a 3-year rule. If the insured transfers an existing policy to the trust and dies within 3 years, the proceeds are included in the estate as if the transfer had not happened. When the trust itself applies for and buys a new policy with its own funds, the rule generally does not apply, because the insured never owned the policy. Courts have accepted this, but the facts of each purchase matter.
- Because the trust usually has no income of its own, the insured commonly gives it money each year to pay premiums. Those transfers are gifts. To qualify them for the annual exclusion ($19,000 per recipient in 2025 and 2026), many ILITs give beneficiaries Crummey withdrawal rights and send notices (lesson 5.1.2). Gifts beyond the exclusion are reported on Form 709 and use part of the insured’s basic exclusion.
- An ILIT can also provide cash when an estate needs it, for example to pay estate tax, debts or expenses without selling a family business or home quickly. Rather than paying the estate’s bills directly, the trustee may be allowed to lend money to the estate or buy assets from it at fair value. Trust terms requiring the trustee to pay the estate’s taxes can risk inclusion under §2042, so drafting matters.
- With the federal basic exclusion at $15,000,000 for 2026 under the One Big Beautiful Bill Act of July 2025, most families will not owe federal estate tax, and fewer need an ILIT for that reason. Some still use one for state estate or inheritance tax, for liquidity or to control how proceeds are paid to heirs. An ILIT also has costs: drafting, yearly gift and notice records, and giving up control of the policy. This lesson describes how ILITs work; it does not suggest using one.
Key facts
- Under IRC §2042, life insurance is in the insured’s gross estate if payable to the executor or if the insured held any incidents of ownership at death.
- Incidents of ownership include the power to change the beneficiary, surrender, assign or pledge the policy, or borrow against it.
- Under IRC §2035, an existing policy transferred to a trust within 3 years of the insured’s death is included in the estate.
- Premium gifts to an ILIT often use Crummey withdrawal rights to qualify for the annual exclusion, $19,000 per recipient in 2025 and 2026.
- The 2026 federal basic exclusion is $15,000,000 per person (One Big Beautiful Bill Act, July 2025).
- Treasury regulations treat a power to change beneficial ownership of a policy as an incident of ownership even when the insured holds it as trustee.
Exercise nine, six, three, one
9CollectList up to 9 facts about a life insurance policy you are reading about (some lists are shorter), such as its owner, insured, beneficiary, death benefit, premium, cash value, issue date or any past transfer.
6ClusterSort them into 6 categories: ownership, beneficiaries, amounts, premiums, dates and transfers, and facts you are unsure about.
3DistillReduce the 6 categories to 3 groups: facts that bear on §2042 incidents of ownership, facts that bear on the 3-year rule, and facts you would ask the insurer or an adviser about.
1CrystallizeWrite 1 sentence explaining, in your own words, why who owns a policy matters as much as who receives the proceeds.
Fact check
Dates, figures and claims checked against the published sources listed below.