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Irrevocable Life Insurance Trust (ILIT)

An irrevocable trust that owns a life insurance policy on the grantor's life, keeping the death benefit proceeds out of the taxable estate while providing liquidity to pay estate taxes, equalize inheritances, or fund wealth transfer strategies.

Vehicle Source: Billionaire Wealth Strategies Verified: 2026-04-07

Definition

An Irrevocable Life Insurance Trust is an irrevocable trust created specifically to own and be the beneficiary of a life insurance policy on the grantor's life. Because the trust (not the grantor) owns the policy, the death benefit proceeds are excluded from the grantor's taxable estate under IRC Section 2042. The proceeds pass to trust beneficiaries both income-tax-free and estate-tax-free, making the ILIT one of the most tax-efficient wealth transfer vehicles available.

How It Works

The grantor creates an irrevocable trust and names a trustee (not the grantor). The trust either purchases a new life insurance policy or receives an existing policy transferred by the grantor. If an existing policy is transferred, a three-year survival rule applies under IRC Section 2035: if the grantor dies within three years of the transfer, the policy proceeds are pulled back into the taxable estate.

The grantor makes annual gifts to the ILIT to cover premium payments. To qualify these gifts for the annual gift tax exclusion, the trustee sends "Crummey notices" to beneficiaries, giving them a temporary right to withdraw the gifted amount. Beneficiaries rarely exercise this right, but the withdrawal power converts what would be a future-interest gift into a present-interest gift eligible for the annual exclusion.

Upon the grantor's death, the trust receives the death benefit proceeds. The trustee then distributes funds according to the trust terms: paying estate taxes, providing for the surviving spouse, equalizing inheritances among children, or funding other trust provisions.

When Entrepreneurs Use This

Estate tax liquidity: Business owners whose estates are illiquid (primarily real estate or business interests) use ILITs to provide cash for estate tax payments without forcing a fire sale of business assets
Inheritance equalization: An entrepreneur leaving the business to one child uses ILIT proceeds to provide equivalent value to other children
Wealth replacement: Paired with a charitable remainder trust, an ILIT replaces the donated assets with tax-free insurance proceeds for the family
Second-to-die policies: Married couples use survivorship policies inside ILITs, which are less expensive and align with the typical timing of estate tax liability (at the second death)

Dew Wealth Perspective

The ILIT addresses the "Readiness" element of the STEWARD framework: ensuring the family has the financial resources to execute the estate plan without disruption. An estate plan that requires selling the family business or liquidating real estate to pay taxes at the worst possible time fails the readiness test.

The Linchpin Partner coordinates the insurance analysis, trust drafting, and ongoing premium funding strategy. The ILIT must be administered properly every year: Crummey notices must be sent, premiums must be paid by the trust (not directly by the grantor), and the trust must maintain proper records. Administrative failures can jeopardize the entire structure.

Frequently Asked Questions

Can I transfer an existing life insurance policy to an ILIT?

Yes, but the three-year survival rule applies. If the grantor dies within three years of transferring the policy, the full death benefit is included in the taxable estate. For this reason, purchasing a new policy inside the ILIT is often preferred.

How much life insurance should the ILIT hold?

The amount depends on the estate's projected tax liability, liquidity needs, and other wealth transfer goals. A common starting point is enough to cover the estimated estate tax bill plus a buffer for valuation uncertainties.

What happens if I cannot afford the premiums?

The trustee can explore options such as reducing the death benefit, converting to a paid-up policy, or using trust assets to pay premiums. The key is addressing premium sustainability before the policy lapses.

Disclosure

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