You may think of life insurance simply: you buy a policy so your loved ones receive financial support when you die. While that remains a core purpose, life insurance also plays a valuable role in estate planning strategies. When used thoughtfully—especially through a life insurance trust—a life insurance policy can help manage taxes, preserve wealth, and provide liquidity for future generations.
What does a life insurance trust do?
An Irrevocable Life Insurance Trust (ILIT) is a common estate planning tool. An ILIT is a legal entity that you cannot change or revoke once created. It allows you to use life insurance more strategically as part of an estate plan. As part of a broader estate planning approach, an ILIT can:
- Provide cash to support trust beneficiaries and, in some cases, your estate
- Control how and when life insurance proceeds are distributed
- Ensure life insurance proceeds are not included in your taxable estate
- Reduce potential estate taxes as part of long-term estate planning tax strategies
To understand how an ILIT works, consider its mechanics. Creating a life insurance trust establishes a separate legal entity that owns the policy. Because the trust—not the insured individual—owns the policy, the proceeds paid at death generally avoid probate, income tax, and estate tax.
The trustee then distributes the proceeds in accordance with the trust’s terms. For example, the trust can delay distributions until a beneficiary reaches a specific age or meets certain conditions.
Who pays for the insurance?
As the grantor of the trust, you influence how premiums are paid, but best practices typically keep you at arm’s length from ownership. Common funding methods include:
- Transferring funds to the trust so the trustee can pay premiums
- Using annual gift tax exclusions through withdrawal rights (often called Crummy powers, which allow beneficiaries to temporarily withdraw gifted amounts to qualify the gifts for the annual gift tax exclusion).
- Paying a single premium for a fully funded policy
In most cases, the trust—not the grantor—pays the premiums to avoid estate inclusion. While another individual can sometimes pay premiums, that approach may raise gift tax concerns and should be carefully reviewed.
Key requirements for an irrevocable life insurance trust
To preserve the intended tax benefits, an irrevocable life insurance trust must meet several requirements:
- The trust must be irrevocable. Once created, you generally cannot change or revoke it.
- You should not serve as a trustee. An independent trustee helps prevent estate tax inclusion.
- Timing matters for existing policies. If you transfer an existing insurance policy into the trust, you must survive at least three years for the proceeds to remain outside your estate. If the trust purchases a new life insurance policy, the three-year rule does not apply.
Failing to follow these rules may undermine the trust’s effectiveness and increase estate tax liability.
Why not have someone else own the policy?
Naming another person as the owner of your life insurance policy may seem easier, but it often creates unintended consequences. Here, ‘owner’ means the person who has the legal rights to control the policy, including changing beneficiaries or making other decisions.
- If the owner dies before you, the policy’s value may become part of their taxable estate
- Their heirs may face unexpected estate taxes
- You lose control over beneficiary designations and policy decisions
A properly structured life insurance trust avoids these risks while supporting long-term estate planning objectives.
A decision for life
Establishing an ILIT can be a powerful component of comprehensive estate planning strategies, especially for families concerned about taxes, asset protection, and multi-generational wealth transfer. To determine if a life insurance trust aligns with your estate planning needs, consult an estate planning attorney.
Andrew Kremer Law offers estate legal services as part of their affiliation with Boulay.