By Andrew Bellm
Irrevocable Life Insurance Trusts, commonly called ILITs, have been a core estate planning tool for decades. But with today’s historically high federal estate tax exemption, many clients and advisors reasonably ask: Do ILITs still matter?
The short answer is yes, but their role has evolved. ILITs are no longer just “estate tax avoidance vehicles.” They are now used more selectively, often as multi-purpose planning tools that combine tax strategy, asset protection, liquidity planning, and family governance.
What an ILIT Does
An ILIT is an irrevocable trust that owns a life insurance policy on the insured’s life. Because the insured does not own the policy and retains no “incidents of ownership,” the death benefit is generally excluded from the insured’s taxable estate under the Internal Revenue Service rules interpreting the Internal Revenue Code.
At death, the trustee receives the policy proceeds and administers them according to the trust terms. The insurance proceeds often provide liquidity for heirs, paying estate expenses, equalizing inheritances, or holding funds in further trust.
Are ILITs Still Relevant Today?
The federal estate tax exemption is historically high (and indexed for inflation), which means fewer estates face federal estate tax than in prior decades. After the passage of the One Big Beautiful Bill Act (OBBBA), those estate tax exemptions are scheduled to remain high into the foreseeable future.
However, estate and inheritance tax issues remain relevant for some families. Many states impose estate or inheritance taxes with much lower exemptions than the federal estate tax exemptions. And for ultra-high-net-worth families, estate tax remains a central concern. In the end, for certain families, ILITS are still a relevant tool in high-net-worth estate planning.
When ILITs Are Typically Used Today
1. Estate Tax Liquidity Planning
Life insurance provides immediate cash at death. An ILIT keeps life insurance proceeds outside the taxable estate while allowing the trustee to:
- Purchase assets from the estate
- Loan money to the estate
- Provide liquidity so heirs don’t have to sell illiquid assets (businesses, real estate)
Life insurance planning can be especially valuable when estates are asset-rich but cash-poor.
2. State Estate Tax Planning
Even if no federal estate tax is due, state-level estate taxes can create significant liability. ILIT proceeds can fund those taxes without increasing the taxable estate.
3. Asset Protection for Beneficiaries
Because ILIT proceeds are held in an irrevocable trust:
- Funds are generally protected from beneficiaries’ creditors
- Funds are generally protected in a divorce
- Spendthrift concerns are addressed
- Professional management can continue across generations
For many families, these non-tax benefits are now important factors when setting up an ILIT.
4. Control Over Wealth Transfer
ILITs allow the grantor to:
- Stagger distributions
- Provide lifetime discretionary support
- Prevent sudden windfalls to unprepared beneficiaries
This control is particularly useful for younger beneficiaries or for families with complex family dynamics.
5. Business Succession & Equalization
In closely held businesses:
- Insurance proceeds can equalize inheritances between children who are active in the business with those who are inactive in the business
- ILITs can provide buy-sell funding without increasing estate tax exposure
6. Generation-Skipping Transfer (GST) Planning
ILITs are often structured as dynasty trusts:
- Insurance proceeds can benefit multiple generations
- With the proper allocation of GST exemption, the ILIT can shield growth from GST transfer tax long-term
Advantages of ILITs
- Estate Tax Exclusion – The death benefit is removed from the decedent’s taxable estate if the ILIT is structured properly.
- Liquidity Without Forced Sales – Life insurance proceeds in a properly structured ILIT provides cash when estates need it most. If estate assets are otherwise illiquid, an ILIT allows for liquidity to pay expenses without the need to sell assets.
- Asset Protection – A properly structured ILIT protects beneficiaries from creditors, divorce, and poor financial decisions.
- Control & Governance – The Grantor dictates timing and conditions of distributions to beneficiaries and controls the Trustee selection.
- Privacy – An ILIT is a private instrument and during the administration process avoids the publicity of probate.
Disadvantages and Practical Friction
- Irrevocability – Once created, terms generally cannot be changed easily. Trustees, trust terms, and beneficiaries may be hard to modify. Additionally, policy changes can be restricted. Modern trust decanting and modification statutes help, but flexibility to make changes is still limited.
- Administrative Complexity – ILITs require ongoing maintenance, including (1) Separate trust administration; (2) annual Crummey notices to beneficiaries; (3) funding of annual premiums; and (4) Trustee responsibilities and costs, especially with a corporate fiduciary.
- Three-Year Rule Risk – If an existing policy is transferred into an ILIT and the insured dies within three years, proceeds may be included within the taxable estate for estate tax purposes.
- Funding Friction – Gifts of insurance premiums to the ILIT must qualify for the annual exclusion, often requiring (1) withdrawal powers for beneficiaries; (2) Crummey notices; and (3) ongoing coordination with beneficiaries
- Costs – Establishing and administering an ILIT may include a variety of costs, including (1) legal fees to draft the document; (2) Trustee fees to administer the trust, especially with a corporate fiduciary serving as Trustee; (3) payment of insurance premiums; and (4) ongoing administration costs. For smaller estates, these costs can outweigh the benefits.
Situations Where ILITs Are Less Useful
ILITs may be unnecessary when:
- Net worth is well below federal and state estate tax thresholds
- Beneficiaries are financially sophisticated
- Simplicity is a priority
- Insurance is not needed for liquidity or leverage
In these cases, outright ownership of the underlying insurance policy may suffice.
Modern Planning Trends
Estate planners increasingly view ILITs as strategic liquidity and asset-protection vehicles that also provide tax efficiency, not merely estate tax shelters.
Common features of an ILIT include:
- Grantor trust status for income tax flexibility
- Dynasty trust structures
- Private split-dollar arrangements
- Premium financing
- Flexibility to decant in decanting-friendly jurisdictions
The Bottom Line
ILITs remain highly relevant, but are primarily used for:
- Taxable estates (federal or state)
- Illiquid estates
- Asset protection planning
- Multigenerational wealth strategies
- Business succession planning
They are no longer automatic recommendations, but when aligned with the right objectives, ILITs remain one of the most powerful tools in sophisticated estate planning.