How does an irrevocable life insurance trust (ILIT) work?

What it is

An ILIT is an irrevocable trust that applies for, owns, and is the beneficiary of life insurance on your life. You make gifts to the trust, the trustee pays the premiums, and at your death the trustee collects the proceeds and holds or distributes them for your beneficiaries.

Because you do not own the policy, the proceeds are generally not included in your gross estate, and the trust can provide liquidity to pay estate tax or equalize inheritances.

What the law says

IRC §2042(2) includes in the gross estate insurance proceeds receivable by other beneficiaries on policies for which the decedent held any incident of ownership at death, such as the power to change the beneficiary, borrow against the policy, or surrender it (see Treas. Reg. §20.2042-1(c)).

IRC §2035(a) includes a transferred interest if the decedent made the transfer within three years of death and the property would have been included under §2036, 2037, 2038, or 2042 had the decedent kept it. This is why a trust usually buys a new policy rather than receiving an existing one.

IRC §2503(b)(1) excludes the first $10,000, indexed for inflation, of gifts to each person in a year, other than gifts of future interests. For 2026 the exclusion is $19,000 (Rev. Proc. 2025-32, §4.42). A beneficiary's temporary right to withdraw a gift, known as a Crummey power, makes the gift a present interest.

IRC §101(a) generally excludes death benefits from income; exceptions such as the transfer-for-value rule can apply to policies acquired by transfer.

Requirements and tests

• You hold no incidents of ownership and do not serve as trustee with powers over the policy.
• The trustee applies for and owns the policy from the start, or you survive a transfer by more than three years.
• Each beneficiary receives a real withdrawal right and written notice with a reasonable period to exercise it, every year a gift is made.
• Withdrawal rights that lapse above the greater of $5,000 or 5% of trust assets can be treated as gifts by the beneficiary (§2514(e)); the trust should be drafted with this in mind.
• GST exemption is allocated on Form 709 if the trust may benefit grandchildren, since Crummey gifts to most trusts do not meet the §2642(c)(2) requirements for a zero inclusion ratio.

How it works

You sign the trust, the trustee obtains an EIN and applies for the policy, and you make annual cash gifts to the trust. The trustee sends Crummey notices, waits for the withdrawal period to lapse, and pays the premium. At death, the trustee collects the proceeds outside your estate and can lend to or buy assets from your estate to provide liquidity.

Many ILITs also hold a second-to-die policy for a married couple, which pays at the second death, when estate tax is usually due, because the marital deduction defers tax at the first death. The same ownership and Crummey rules apply. If the trust will benefit grandchildren, allocating GST exemption to the premium gifts lets the proceeds pass free of GST tax as well.

The trustee should keep a file with the trust agreement, the policy, annual premium notices, each Crummey letter and proof of delivery, and the gift tax returns that report the gifts and any GST allocation. That file is what examiners and successor trustees will ask for.

Risks and IRS scrutiny

Common failures are maintenance failures: notices never sent, premiums paid directly by the insured, the insured acting as trustee, or an existing policy transferred shortly before death. Examiners review Schedule D of Form 706 and the trust's history; the Internal Revenue Manual includes a life insurance lead sheet. The trust is also irrevocable, so changing it later may require decanting or a court proceeding.

Who it is not for

This is not for estates expected to stay under the exemption, unless there are non-tax goals such as asset management for heirs, or for anyone unwilling to give up control of the policy. It is also not for anyone who is uninsurable and would have to transfer an existing policy at high risk under the three-year rule.

How ebotCPA helps

We audit the trust's records: policy ownership, transfer dates, Crummey notices, gift tax returns, and GST allocations. We model whether your estate is likely to exceed the exemption. We coordinate with your attorney, who drafts the legal documents.

Book a $497 Case Analysis to have Ebot Mbi, CPA, EA review your facts before you act.

Primary sources

1. 26 U.S.C. §2042(2). Proceeds of life insurance.

   “To the extent of the amount receivable by all other beneficiaries as insurance under policies on the life of the decedent with respect to which the decedent possessed at his death any of the incidents of ownership, exercisable either alone or in conjunction with any other person.”

   Includes proceeds payable to other beneficiaries if the decedent held incidents of ownership at death.

2. 26 U.S.C. §2035(a). Transfers within three years of death.

   “if such transferred interest or relinquished power had been retained by the decedent on the date of his death”

   Brings back transferred interests, such as a life insurance policy, that would have been included under §2042 if retained.

3. 26 U.S.C. §2503(b)(1). Gift tax annual exclusion.

   “In the case of gifts (other than gifts of future interests in property) made to any person by the donor during the calendar year, the first $10,000 of such gifts to such person shall not, for purposes of subsection (a), be included in the total amount of gifts made during such year.”

   Excludes indexed annual gifts of present interests per donee.

4. Treas. Reg. §20.2042-1. Incidents of ownership.

   Defines incidents of ownership for §2042.

5. Rev. Proc. 2025-32, §4.42. 2026 annual exclusion.

   Sets the 2026 annual exclusion at $19,000 per donee.

6. IRM 4.25.5.2.8. Schedule D (life insurance) lead sheet.

   Guides examiners reviewing life insurance included in or excluded from the estate.

Frequently asked questions