Irrevocable Life Insurance Trusts (ILITs)

The calls follow patterns. The 62-year-old executive with a $4M term policy through her former employer, now portable, whose estate planner has just told her the policy is included in her taxable estate. The business owner whose $2M whole-life policy was put in place 20 years ago "for the kids" and is still owned by him personally. The couple in their 50s whose net worth and insurance coverage are approaching the federal exemption, who are looking ahead to a transfer-tax exposure they did not have five years ago. The widower whose late wife's irrevocable life-insurance arrangement was never properly funded with Crummey notices and whose successor planner is unwinding the contribution-tax exposure.

What these stories share is a quiet assumption that life insurance "passes outside the estate." For income-tax purposes, the death benefit ordinarily does pass income-tax-free to the beneficiary. For estate-tax purposes, the answer can be the opposite: a policy the insured owns — or merely holds the strings to — is ordinarily pulled into the gross estate for its full death benefit. A $4 million policy can therefore add $4 million to the estate-tax base, even though the family never thought of it as part of the estate at all.

The Irrevocable Life Insurance Trust is the planning answer to that problem. It is a separate, irrevocable trust that owns the policy in place of the insured, so the proceeds can land outside the gross estate while still reaching the people the insured intended to protect — a surviving spouse, children, grandchildren — through the trust's own terms. It is most relevant for families whose combined net worth and insurance coverage approach or exceed the federal exemption, and for families who want the death benefit available to pay an estate-tax bill without selling a business or a home to raise the cash. Below, we walk through how the structure works, the two traps that defeat it most often, and when it is — and is not — the right tool.

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 § 2035source 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 § 2042source.
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)source 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)source 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. 54:34-4source. 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 § 2632source 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.

Frequently Asked Questions

What is an Irrevocable Life Insurance Trust (ILIT)?

An ILIT is an irrevocable trust that owns a life insurance policy on the grantor's life. The trust — not the insured — is the policy owner and the death-benefit beneficiary. When the insured dies, the proceeds pay into the trust outside the insured's taxable estate, then are distributed to trust beneficiaries under the trust terms. Properly structured ILITs can exclude the death benefit from the federal estate tax under IRC § 2042.

Why move life insurance out of my estate using an ILIT?

Life-insurance proceeds are included in the insured's gross estate under IRC § 2042 when the insured holds 'incidents of ownership' — the right to change beneficiaries, borrow against the policy, surrender it, or assign it. Owned by the insured at death, a $5 million policy adds $5 million to the federal taxable estate. The federal exemption is $15 million per individual for 2026 and indexed after 2026, so policy ownership can still matter for estates approaching or exceeding that threshold. Owning the policy through a properly structured ILIT can move the proceeds outside the gross estate.

What is the three-year lookback rule under IRC § 2035?

If you transfer an existing life-insurance policy to an ILIT and die within three years, IRC § 2035(a) brings the policy back into your gross estate — defeating the planning. To avoid the lookback, the ILIT should buy a new policy directly from the start so there is no transfer from the insured to the trust. This requires the trustee to apply for and own the policy from inception, with funding via Crummey-power gifts.

What are Crummey powers and why does my ILIT need them?

Gifts to fund premium payments are taxable gifts. To qualify for the annual exclusion ($19,000 per donee in 2026; indexed annually), the gift must be a 'present interest.' A Crummey power — named after Crummey v. Commissioner, 397 F.2d 82 (9th Cir. 1968) — gives each beneficiary the temporary right to withdraw their proportionate share of contributions for a specified period. Beneficiaries are notified in writing of their withdrawal right; the right is allowed to lapse; the funds remain in the trust to pay premiums. The Crummey power converts a gift to a future interest into a gift of a present interest, qualifying it for the exclusion.

Are ILITs subject to the NJ estate tax?

NJ repealed its estate tax for deaths after January 1, 2018 (P.L. 2016, c. 57). Properly structured ILITs can exclude proceeds from the federal taxable estate under IRC § 2042. The NJ inheritance tax under N.J.S.A. 54:34 applies to specific transferee categories, but life-insurance proceeds paid to a named beneficiary are generally exempt from NJ inheritance tax under N.J.S.A. 54:34-4. The federal estate tax remains the primary driver of ILIT planning for NJ residents.

Can I be the trustee of my own ILIT?

No. As the insured, you generally should not serve as trustee of your own ILIT. Trustee powers (the ability to surrender the policy, change beneficiaries, borrow against it) are 'incidents of ownership' under IRC § 2042. Holding them can defeat the planning. Typical trustees: spouse with careful drafting; adult child; sibling; professional trustee; independent attorney-trustee.

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