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How to Reduce Estate Taxes with an Irrevocable Life Insurance Trust (ILIT)

, AIF ®, ChFC®, CFP®

10/22/2025

8 minutes

When planning your estate, preserving your wealth for future generations often comes down to one key strategy: minimizing estate tax liability. One powerful and often underutilized tool in this effort is the Irrevocable Life Insurance Trust (ILIT). When implemented properly, an ILIT can help reduce estate taxes, protect life insurance proceeds, and ensure a smooth transfer of wealth.

But what is an ILIT, how does it work, and is it right for you? Below, we explore everything high-net-worth individuals need to know about irrevocable life insurance trusts as part of a comprehensive estate plan.

What Is an Irrevocable Life Insurance Trust?

An Irrevocable Life Insurance Trust (ILIT) is a special type of trust designed specifically to own and manage a life insurance policy outside of your taxable estate. Once the trust is created and funded, the policy becomes the property of the ILIT, not you.

This means:

The death benefit is excluded from your estate.
Your beneficiaries can access the proceeds tax-free (subject to certain conditions).
The trust controls how and when funds are distributed.

Because the trust is irrevocable, you cannot make changes once it’s established. But in exchange for that permanence, you gain meaningful estate tax advantages.

How Does an ILIT Help Avoid Estate Taxes?

Ordinarily, the death benefit of a life insurance policy is included in your gross estate for estate tax purposes, see 26 CFR § 20.2042-1. For 2025, the federal estate tax basic exclusion amount is $13.99 million per person, per the IRS. Anything above this threshold may be taxed up to 40% at the federal level, plus applicable state estate taxes.

Here’s where an ILIT helps:

Removes the policy from your estate – Because the trust owns the policy, the death benefit is not considered part of your taxable estate.
Shelters wealth from federal and state estate taxes – This is especially valuable in states like Massachusetts and Oregon that have low estate tax exemptions.
Preserves more wealth for heirs – Rather than losing up to 40% to estate taxes, your beneficiaries may receive the full value of the life insurance payout.

Real-world example: Let’s say you live in Minnesota with a $20 million estate. Without proper planning, about $6.4 million could be subject to estate taxes. However, by placing a $5 million life insurance policy inside an ILIT, that benefit is excluded from your estate, potentially saving millions in taxes.

Additional Benefits of an ILIT

An ILIT offers more than tax savings. It can also help you (see our related post on Avoiding Estate Taxes on a Life Insurance Policy):

Control the timing of distributions (e.g., stagger payments for young beneficiaries).
Preserve assets from creditors or potential misuse.
Fund estate tax liabilities without selling other assets.
Provide liquidity for estate settlement expenses.

Because the trust terms dictate how the life insurance proceeds are used, you can tailor them to fit your family’s needs and values.

Potential Drawbacks to Consider

While ILITs can be highly effective, they come with some considerations:

They are irrevocable – Once created, you lose control over the policy.
Gift tax rules may apply – Funding the trust with premiums or an existing policy may trigger gift tax concerns.
Ongoing administration – The trustee must manage Crummey notices and premium payments to maintain tax advantages.

Working with a financial advisor is essential to properly structure and maintain the ILIT.

Is an Irrevocable Life Insurance Trust Right for You?

An ILIT is often ideal for:

High-net-worth individuals with large life insurance policies
Families looking to preserve generational wealth
Business owners who need liquidity to fund succession plans
Individuals in states with low estate tax exemptions

If your estate may exceed the federal or state exemption threshold, or if you're concerned about the impact of estate taxes on your heirs, an ILIT is worth exploring.

Key Takeaways

ILITs remove life insurance from your taxable estate, helping reduce or avoid estate taxes.
They give you control over how and when funds are distributed to your beneficiaries.
They can help protect wealth from taxation, creditors, and poor financial decisions.
They require careful setup and ongoing administration to maintain benefits. For gifting mechanics that may support premium funding, see our post Estate Tax Planning Using the Annual Gift Tax Exclusion.

Next Steps

To find out if an irrevocable life insurance trust is right for your estate plan, talk with a financial advisor. They can help you:

Evaluate your estate size and tax exposure
Determine the best type of policy for the trust
Draft the legal documents and manage compliance

When thoughtfully crafted, an ILIT can be one of the most effective tools for reducing estate taxes and preserving your legacy.

Frequently Asked Questions About Irrevocable Life Insurance Trusts (ILITs)

What exactly is an ILIT?

An Irrevocable Life Insurance Trust (ILIT) is a trust created to own a life insurance policy outside of your taxable estate. The trustee, not you, owns and controls the policy according to the terms laid out in the trust document. Because ownership is transferred, the policy’s death benefit is generally not counted in your estate for estate tax purposes.

How can an ILIT help reduce estate taxes?

If you personally own a life insurance policy, the death benefit is typically included in your taxable estate. By moving ownership to an ILIT, the proceeds are generally excluded from your estate, which can help reduce potential federal and state estate taxes and keep more of the policy’s value available for your beneficiaries.

Who typically considers using an ILIT?

Families who expect their estate to exceed federal or state estate tax exemptions, individuals with large permanent or term policies, business owners seeking liquidity for succession needs, and couples using survivorship (second‑to‑die) insurance often evaluate ILITs.

Should I buy a new policy inside the ILIT or transfer an existing policy?

Either approach can work. Purchasing a new policy directly in the ILIT avoids certain look‑back rules. Transferring an existing policy can be appropriate too, but it may have additional tax considerations (see the “3‑year rule” below). Your can help compare options.

What is the “3‑year rule” I’ve heard about?

If you transfer an existing policy to an ILIT and pass away within three years of the transfer, the IRS can treat the death benefit as part of your estate. See 26 U.S.C. § 2035 for the statutory three-year rule. This rule does not apply if the ILIT purchases a new policy from the outset. Your planning team can help you weigh timing considerations.

How are premium payments made once the ILIT is set up?

Typically, you make gifts to the ILIT and the trustee uses those funds to pay premiums. Gifts may qualify for the annual gift tax exclusion ($19,000 per donee in 2025). See IRS guidance on Gifts & Inheritances here. With proper administration, these gifts can qualify for the annual gift tax exclusion.

What are “Crummey notices,” and why do they matter?

To qualify gifts for the annual exclusion, many ILITs give beneficiaries a temporary right to withdraw the contribution (a “Crummey power”), upheld in Crummey v. Commissioner, 397 F.2d 82 (9th Cir. 1968). The trustee notifies beneficiaries of this right, often called a Crummey notice, and keeps records. Proper notices are an important part of maintaining the ILIT’s tax benefits.

Who should serve as trustee?

You’ll name an independent trustee (a trusted individual or corporate trustee). To preserve tax benefits and avoid control issues, the insured generally should not act as trustee. Some families also name a trust protector who has limited powers to adjust certain administrative terms if laws or circumstances change.

Can I change beneficiaries or the trust terms later?

An ILIT is irrevocable, so you typically cannot rewrite core terms after it’s created. That said, your attorney can draft provisions that allow limited flexibility, such as permitting a trust protector to modify administrative details or using state law techniques like decanting where available.

What happens to the policy’s cash value?

If the ILIT owns a permanent policy with cash value, the trustee controls it. The trustee may access cash value or policy loans for the benefit of the trust/beneficiaries, consistent with the trust terms. The insured generally cannot access cash value personally once the policy is owned by the ILIT.

How do gift and generation‑skipping transfer (GST) taxes come into play?

Gifts to fund premiums may be covered by the annual gift tax exclusion and/or your lifetime gift and estate tax exemption (basic exclusion amount). For GST planning, see 26 CFR § 26.2632-1 on allocating GST exemption. If grandchildren (or lower‑generation beneficiaries) are included, your attorney can help allocate GST exemption to the ILIT to address potential GST tax.

What if I stop funding the trust or the policy lapses?

If premium funding stops, the trustee may consider options such as using cash value (if any), reducing the death benefit, or exploring a paid‑up policy. These choices can affect coverage and long‑term value, so advance planning for reliable premium funding is important.

Will an ILIT help with state estate or inheritance taxes?

Often, yes. Many states have separate estate or inheritance taxes with exemption amounts lower than the federal level. Keeping the life insurance death benefit outside of your estate can help manage potential state‑level taxes as well.

Can an ILIT own a survivorship (second‑to‑die) policy for married couples?

Yes. Survivorship policies, paying a death benefit after the second spouse’s death, are commonly owned by ILITs because they can be a cost‑effective way to provide liquidity for taxes or other obligations due at the second death.

How does an ILIT provide liquidity for my estate?

Your trust can be directed to lend money to your estate or purchase illiquid assets from your estate after death, providing cash to pay taxes or expenses without forcing a sale of family property or a business at an inopportune time.

Are there drawbacks to consider?

Key trade‑offs include loss of control (it’s irrevocable), ongoing administration (trustee work and Crummey notices), legal and trustee fees, and the need for consistent premium funding. Many families find the estate‑tax and control benefits outweigh these considerations, but it’s important to evaluate them upfront.

What happens if tax laws change?

Trusts can be drafted with built‑in flexibility (discretionary distribution standards, trust protector provisions, decanting authority where permitted). Even so, periodic reviews with your advisor and attorney are wise to keep your plan aligned with current law and your goals. For context on the scheduled post-2025 changes and “no-clawback,” see the IRS Estate and Gift Tax FAQs.

What other strategies pair well with an ILIT?

Depending on your situation, your team may also discuss spousal lifetime access trusts (SLATs), grantor retained annuity trusts (GRATs), charitable trusts, buy‑sell agreements, or other techniques. An ILIT often serves as the life‑insurance component within a broader, integrated estate plan.

Sources and Further Reading

IRS: Tax inflation adjustments for tax year 2025 (estate and gift)
IRS: Estate and Gift Tax FAQs (no-clawback clarification)
Cornell LII: 26 CFR § 20.2042-1, Proceeds of life insurance
Cornell LII: 26 U.S.C. § 2035, Three-year rule
Justia: Crummey v. Commissioner, 397 F.2d 82 (9th Cir. 1968)
Cornell LII: 26 CFR § 26.2632-1, Allocation of GST exemption

About the author

Adria joined Wealth Enhancement Group in 2013 through a merger with Summit Wealth Advisors. With over 15 years of experience, Adria is passionate about empowering clients with tailored financial planning solutions. Known for her innovative approach, she expertly balances her clients' needs with forward-thinking strategies to create personalized financial journeys.

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