Irrevocable Life Insurance Trusts

What an ILIT Does

An irrevocable life insurance trust owns a life insurance policy on your life so that the death benefit is available to your family without being counted as part of your taxable estate.

The mechanism is straightforward. If you own a policy on your own life, or hold certain rights over it, the full death benefit is included in your gross estate for federal estate tax purposes. If a properly drafted irrevocable trust owns the policy instead, and you retain none of those rights, the proceeds pass to your beneficiaries outside your taxable estate. Life insurance death benefits are also generally free of federal income tax; an ILIT adds the estate tax exclusion.

Does This Still Matter at Today’s Exemption Levels?

For most families, not for estate tax reasons — and that is the honest answer.

For 2026 the federal estate and gift tax exclusion is $15 million per person, made permanent and indexed for inflation by legislation enacted in 2025, so the reduction that had been scheduled to take effect after 2025 did not occur. Amounts above the exclusion are taxed at 40%. California imposes no separate estate tax.

A married couple can potentially shelter $30 million, but that result is not automatic. It assumes both exclusions remain available and, where the first spouse’s exclusion is not fully used, that a portability election is made on a timely filed estate tax return. The generation-skipping transfer tax exemption is a separate $15 million per person and is not portable — an unused GST exemption is simply lost at the first death, which is one reason multigenerational planning has to be done deliberately rather than assumed.

If your combined net worth including life insurance is comfortably below those thresholds, an ILIT is unlikely to save you any estate tax, and you should be skeptical of anyone who tells you otherwise.

That said, estate tax was never the only reason to use one, and for a significant number of our clients the other reasons are the real ones.

The Reasons That Still Apply

Liquidity. Federal estate tax, where it applies, is generally due nine months after death, in cash. An estate also faces final medical bills, funeral costs, income taxes for the decedent’s last year, and administration expenses, each on its own schedule. Families whose wealth sits in a closely held business, a ranch, rental property, or a single valuable home often have limited cash to meet those obligations, and the alternative is selling an asset under time pressure at a price that reflects it. Insurance provides a source of liquidity that does not require selling anything.

Creditor and marital-property considerations for your beneficiaries. Proceeds paid outright to a beneficiary become that beneficiary’s own property, where they may be exposed to creditor claims and may become entangled in a marital dissolution, depending on the circumstances and on how the funds are handled after receipt. A trust with properly drafted spendthrift provisions can provide substantial protection while keeping the funds available for the beneficiary’s support.

Beneficiaries who should not receive money outright. Insurers generally will not pay proceeds directly to a minor or to an incapacitated adult, which means a court-supervised guardianship or conservatorship — expensive, public, and slow. A trust avoids that. Where a beneficiary receives needs-based public benefits such as Medi-Cal or SSI, an outright payment can disqualify them, and the trust must be drafted with that beneficiary specifically in mind; see the note under funding below, because the ordinary funding mechanism creates a problem for exactly this beneficiary.

Blended families. Where you want to provide for a surviving spouse during their lifetime but ensure that what remains passes to children from a prior marriage, a trust controls that outcome. A beneficiary designation cannot.

Business succession. Life insurance can fund a buy-sell agreement or equalize inheritances where one child receives the family business and others do not. The structure matters a great deal. In Connelly v. United States (2024), the Supreme Court held that life insurance proceeds received by a corporation to redeem a deceased shareholder’s stock increased the corporation’s value for federal estate tax purposes, and were not offset by the corporation’s obligation to redeem. Company-owned insurance and buy-sell arrangements should be reviewed against that decision and coordinated with the owner’s estate plan; an entity-purchase structure that made sense a few years ago may not now.

Generation-skipping planning. An ILIT can be drafted so the proceeds benefit children during their lives and pass to grandchildren without a second estate tax, using the generation-skipping transfer tax exemption. Because that exemption is not portable, allocating it correctly during life and at the first death matters.

Larger estates. For clients who genuinely exceed the exclusion, the original analysis is unchanged and the savings are substantial. For married couples the trust often holds a survivorship policy — sometimes called second-to-die — which insures both spouses, generally costs less than two individual policies, and pays at the second death, which is when the estate tax is actually due.

How the Money Reaches the Estate

This is the part clients most often misunderstand, and it matters.

The trust should not be obligated to pay your estate’s taxes or debts. Proceeds that the executor can require the trust to pay over risk being treated as receivable by the estate and included in it — the opposite of the intended result.

What the trust can do is deal with your estate at arm’s length. The trustee is given discretionary authority to lend money to your estate or living trust, or to purchase assets from it. Either transaction puts cash where the tax and expenses must be paid, and leaves the estate holding a note or the sale proceeds instead of the illiquid asset it could not otherwise afford to keep. The family business or the ranch stays in the family; the trust holds a receivable.

The distinction is a drafting matter, and it is why these trusts should not be assembled from a form.

Why Not Simply Have My Spouse Own the Policy?

If your spouse owns the policy and predeceases you, its value is included in their estate. If your spouse survives you, whatever remains of the proceeds is included in theirs at the second death. Spousal ownership defers the issue rather than solving it, and it offers no creditor protection and no control over where the money ultimately goes.

Why Not Have My Children Own It?

Several problems. Coordinating premium payments among several owners is cumbersome, and naming only one child to keep it simple creates the risk that the child declines to share — or shares, and makes a taxable gift in doing so. Any child who owns the policy can cash it in during your lifetime and defeat the plan. A policy owned by your child may also be exposed to that child’s creditors, tax liens, bankruptcy, or dissolution proceedings. You may have every confidence in your children today; you cannot control what happens to them over the next thirty years.

A trust gives you the same people in a fiduciary role, with duties they must observe and no authority to redirect the money.

A California Point: Community Property

California is a community property state, and that changes the analysis in ways a national article will not tell you.

If premiums on a policy insuring one spouse are paid with community funds, the community acquires an interest in the policy. When that policy is transferred to an irrevocable trust, both spouses are in substance making the gift, and half the value may be attributable to the spouse who is not insured. That affects who reports the gift, whose exclusion is used, and — where the non-insured spouse is also a trust beneficiary — whether the trust has been structured to avoid pulling the proceeds back into that spouse’s estate.

The usual solutions are to have both spouses join in the transfer, or to transmute the policy to the insured spouse’s separate property before the transfer. California requires a transmutation to be made by an express written declaration; an informal understanding between spouses will not do it, and neither will simply retitling the policy.

If you are married, own a policy, and are considering a trust, bring us the premium history along with the policy. Where the money came from matters.

How the Trust Is Funded

The trust needs cash to pay premiums, and that cash comes from you as a gift.

For 2026 the annual gift tax exclusion is $19,000 per recipient. To qualify for it, a gift must be of a “present interest,” and a gift into a trust ordinarily is not. Married couples have additional options, including splitting gifts, which carry their own filing requirements; we will tell you what applies to your situation.

The solution to the present-interest problem is a withdrawal right, commonly called a Crummey power after the Ninth Circuit case that approved it. When you transfer funds to the trust, the trustee notifies each beneficiary in writing that they may withdraw their share within a stated window, typically thirty days. That right of withdrawal is what makes the gift a present interest. If the window closes without a withdrawal, the trustee applies the funds to the premium.

The withdrawal right must be genuine. Notices must actually be given, the window must be real, and the beneficiary must be free to exercise the power. A withdrawal right that everyone understands in advance will never be used is precisely what the Service looks for in challenging these trusts, and we draft and administer them accordingly.

In practice the notice requirement is a routine annual step rather than a burden, and we give trustees the forms and the schedule to handle it correctly.

One important exception. A beneficiary who receives needs-based public benefits should generally not be given a withdrawal right. The power to withdraw funds is itself typically treated as an available resource for Medi-Cal and SSI purposes, so the very mechanism that secures the gift tax exclusion can cost that beneficiary their eligibility — and the harm is done whether or not the power is exercised. Where a trust has a beneficiary in this position, the withdrawal rights are allocated among the other beneficiaries, or that beneficiary’s interest is held in a separate share drafted to supplement rather than replace public benefits. This is a common situation and an entirely solvable one, but it has to be identified before the trust is signed, not after.

Should I Serve as Trustee of My Own ILIT?

No. Powers held over a policy can be attributed to the insured even when held in a fiduciary capacity, and the resulting estate inclusion is the precise outcome the trust exists to prevent. We do not structure them that way.

The trustee should be an adult child, another trusted individual, or a professional fiduciary. In many cases it is the same person you have named as successor trustee of your living trust.

Can I Transfer a Policy I Already Own?

Yes, subject to two rules. If you die within three years of transferring an existing policy, the proceeds are pulled back into your gross estate as though the transfer had not occurred. And the transfer is itself a gift, which must be valued and may require a gift tax return — the valuation depends on the type of policy and its status, and is not simply the face amount.

Neither is a reason to delay. The three-year clock only runs if it is started.

Where circumstances warrant, a sale of the policy to the trust rather than a gift can avoid the three-year rule entirely. That approach requires care: a sale of a policy for value ordinarily costs the buyer the income tax exclusion on the death benefit, which would defeat the purpose. The technique works only because a trust treated as wholly owned by the insured for income tax purposes is treated as the insured for this rule, bringing the sale within a statutory exception. Structured correctly it is a useful tool; structured carelessly it converts a tax-free death benefit into a taxable one.

Bring us the policy and we will tell you which approach fits.

The Trust Is Irrevocable. How Rigid Is That?

Genuinely irrevocable: you cannot simply amend it, and you should not sign one you do not fully understand.

But irrevocable is not the same as unchangeable. California law provides several mechanisms that may permit an irrevocable trust to be modified, or its assets moved to a trust with updated terms, where the statutory requirements are met — modification with the consent of the settlor and beneficiaries, court modification where circumstances have changed, and decanting by a trustee holding discretionary distribution authority. Whether any of them is available depends on the trust’s terms and the facts. We also draft in flexibility from the outset: trust protectors, powers of appointment, and trustee removal provisions that let the structure adapt without a court.

Given how much the estate tax exemption has moved over the past twenty years, we assume the law will change again and draft accordingly.

Is Life Insurance a Good Investment?

We are not investment advisers and we do not sell insurance, so treat this as an observation rather than advice.

An ILIT can hold a term policy, and often should — term is the usual choice where the need is temporary, such as covering a buy-sell obligation until a business is sold or protecting young children until they are grown. Most ILITs designed for estate liquidity hold permanent insurance, because the need arises whenever death occurs rather than within a fixed window.

Whether a permanent policy makes sense depends on your age, health, cash flow, what else you would do with the same premium dollars, and what the policy is actually for. A policy purchased to solve a specific problem — funding a buy-sell agreement, providing liquidity for an illiquid estate, equalizing inheritances among children — is being asked to do something other investments do not do, and should be evaluated on that basis. A policy sold as a general savings vehicle deserves harder scrutiny and a careful look at the illustration’s assumptions.

We are glad to review a proposal with you, and to refer you to insurance professionals we know if you need one.

Talk With Us

Whether an ILIT belongs in your plan depends on the size and composition of your estate, who your beneficiaries are, and what you are trying to protect against. If you would like to discuss it, call our Camarillo office at (805) 482-2282 or use the contact form to schedule a consultation.

Principal authorities: I.R.C. §§ 101(a), 2010(c), 2035(a), 2042, 2503(b), 2513, 2631; Treas. Reg. §§ 20.2042-1, 25.2512-6; Rev. Rul. 2007-13; Crummey v. Commissioner, 397 F.2d 82 (9th Cir. 1968); Connelly v. United States, 602 U.S. 257 (2024). California: Prob. Code §§ 15300–15309 (spendthrift provisions), §§ 15403–15409 (modification and termination), § 19501 et seq. (decanting); Fam. Code § 852 (transmutation). Inflation-adjusted figures for 2026 are from Rev. Proc. 2025-32. This page describes general principles and is not legal advice as to any particular situation.