Irrevocable Life Insurance Trusts (ILITs)

How an ILIT works

1. Trust creation. An irrevocable trust is drafted with the insured as grantor, but the trust -- not the insured -- as the policy owner and beneficiary. The trustee is someone other than the insured.
2. Policy purchase. The trustee applies for a life-insurance policy on the insured's life. The trust pays the initial premium. New policy (not transfer) avoids the IRC § 20351 three-year lookback.
3. Annual premium funding via Crummey gifts. The grantor makes annual gifts to the trust to fund premiums. Each beneficiary receives a written Crummey notice giving them a set window -- often 30 days -- to withdraw their proportionate share. When the window passes without a withdrawal, the right lapses and the trust uses the funds to pay the premium. The withdrawal right is what makes the gift a present interest, qualifying it for the annual gift-tax exclusion.
4. Death benefit payment. On the insured's death, the policy pays the death benefit to the trust. Because the trust held the policy (with no incidents of ownership in the insured), the proceeds can be excluded from the gross estate under IRC § 20422.
5. Distribution to beneficiaries. The trust distributes proceeds (or holds them in continued trust) under the terms drafted into the ILIT -- often providing for the surviving spouse's lifetime access, then to children and grandchildren under generation-skipping protections.

The three-year lookback -- and how to avoid it

IRC § 2035(a)1 pulls back into the gross estate any life-insurance policy transferred by the insured to an ILIT within three years of death. Two avoidance strategies:

• Have the trustee buy a new policy from inception. If the ILIT trustee applies for and owns the policy from day one, there's no transfer from the insured -- the lookback doesn't apply.
• Wait three years. If transferring an existing policy is unavoidable -- because the insured is no longer insurable, or the existing coverage is too valuable to replace -- the proceeds are ordinarily kept outside the gross estate once the insured survives three full years from the transfer date. The clock runs from the transfer; it is not reset by later converting or replacing the same policy, so a transfer-then-replace maneuver does not cure an earlier transfer. For an insured whose health or age makes a fresh trustee-owned policy impractical, the surest path is to make the transfer promptly and plan around the three-year exposure rather than rely on it.

Crummey powers in detail

The Crummey power is the technical heart of ILIT premium funding:

• The trust grants each named beneficiary the right to withdraw their proportionate share of any new contribution.
• The withdrawal period is typically 30 days (sometimes 60).
• The trustee delivers a written Crummey notice to each beneficiary describing the contribution, the beneficiary's withdrawal right, and the deadline.
• If the beneficiary doesn't exercise the right within the period, it lapses and the funds remain in the trust.
• Lapsed powers create technical issues -- the "5-and-5" limitation under IRC § 2514(e)1 treats a lapse beyond the greater of $5,000 or 5% of trust assets as a taxable gift by the lapsing beneficiary to the other beneficiaries. Where annual premiums exceed that ceiling, ILITs are commonly drafted with hanging powers, vested portions, or other techniques so the excess does not produce an unintended gift by the beneficiary.
• Each annual contribution requires fresh Crummey notice administration. This is where ILITs most often fail in practice: missing or late notices can defeat the present-interest exclusion and convert what was meant to be an excluded gift into a taxable one. The administration is not a formality -- it is the part of the plan that has to happen every single year, on time, for the structure to do what it promises.

NJ estate and inheritance tax considerations

For a New Jersey resident, the ILIT question is almost entirely a federal one. New Jersey repealed its state estate tax effective January 1, 2018, so there is no longer a state-level estate tax driving insurance planning here. And life-insurance proceeds paid to a named beneficiary are exempt from the NJ inheritance tax under N.J.S.A. 54:34-41. That leaves the federal estate tax as the real reason a New Jersey family builds an ILIT.

For 2026 the federal basic exclusion amount is $15 million per individual, indexed after 2026. A married couple can ordinarily shelter twice that. Those figures sound comfortably out of reach for most families -- and for many, an ILIT is unnecessary. But the numbers move in ways people underestimate: a closely held business, appreciating real estate, retirement accounts, and a sizeable life-insurance policy can add up quickly, and exemption levels are a creature of statute that Congress can lower. The ILIT analysis is therefore less about today's net worth in isolation and more about the trajectory of the estate and the size of the policy relative to the exemption over time.

Common ILIT planning configurations

"ILIT" describes a function, not a single document. The right configuration depends on whose life is insured, when the family expects the tax to come due, and what the proceeds are meant to do. The structures below are the ones we draft most often:

• Survivorship ILIT (Second-to-Die ILIT). Holds a survivorship policy on the joint lives of both spouses, paying at the second death. Common where the marital deduction defers tax to the second spouse's death; the ILIT funds the federal estate-tax liability that becomes due then.
• Crummey ILIT with hanging powers. Standard configuration for premium funding within the annual exclusion.
• GST-exempt ILIT. Dynasty-trust structure where the ILIT is designed to skip generations, with GST allocation under IRC § 26321 to shelter the trust from generation-skipping transfer tax.
• Spousal Access ILIT. Permits the non-insured spouse to be a beneficiary during her lifetime -- providing indirect access to the trust assets while keeping the proceeds out of the insured's estate.
• Buy-Sell ILIT. The ILIT holds the policies that fund a buy-sell agreement, so that on a business owner's death the surviving owners (or the entity) have liquidity to purchase the deceased owner's interest -- without the proceeds inflating the deceased owner's taxable estate.

These are not mutually exclusive. A survivorship ILIT for a married couple is often also drafted with GST-exempt, dynasty-style terms; a spousal-access feature can be layered onto either. The selection is a drafting decision we make with the family once we understand the estate, the policy, and who is meant to benefit.

When an ILIT is -- and is not -- the right tool

An ILIT is not the answer for every policyholder, and a responsible analysis says so plainly. For a family whose combined assets sit comfortably below the federal exemption and are expected to stay there, the cost and annual administration of an ILIT may outweigh the benefit, and a straightforward beneficiary designation can do the job. The structure earns its keep in a specific zone: estates that approach or exceed the federal exemption, especially where a large policy, appreciating real estate, a business interest, or a blended family raises the stakes of getting the proceeds out of the taxable estate. It is exactly those situations -- not the simplest ones -- where the irrevocable trust does work that a beneficiary form cannot.

The honest cautions run the other way:

• If the policy is term life the insured may well outlive, there may be no death benefit to plan around -- though a convertible term policy can sometimes be brought into an ILIT before it lapses.
• If the estate is comfortably below the federal exemption and is expected to stay there, the ILIT's cost and annual Crummey administration can outweigh the tax benefit.
• If the insured wants to keep the right to change beneficiaries, borrow against the policy, or otherwise control it, an ILIT is the wrong fit. Irrevocability is the entire point, and those retained powers are precisely the "incidents of ownership" that pull the proceeds back into the estate.
• If the family genuinely values the simplicity of a beneficiary designation over trust administration, and the estate is not large enough to need the shelter, the simpler path can be the better one.

The point of listing these is not to talk anyone out of an ILIT. It is to be candid that the structure is a deliberate trade -- control surrendered in exchange for an estate-tax result -- and that the trade is worth making when the numbers and the family circumstances call for it. Where they do not, we will tell you so.

How we help: We review policy ownership, the three-year transfer rule, premium funding, annual-exclusion notices, trustee selection, beneficiary standards, business-liquidity needs, and GST or estate-tax objectives before choosing the ILIT structure. The accepted engagement uses bespoke trust drafting, not an ILIT template. Request an ILIT policy and ownership review.