Do You Need a Life Insurance Trust?

life insurance

An Irrevocable Life Insurance Trust (“ILIT”) is a valuable estate planning tool used to reduce estate taxes – known as death taxes during an election year. Whether you need an ILIT depends on how much your assets are worth now or what your potential net worth is in the future. Some benefits of an ILIT are for paying Federal and State estate tax due at death, avoiding forced liquidation of assets, and equalizing inheritances between beneficiaries -especially when a closely held business is involved.

Do You Have a Taxable Estate?

Most people do not currently have a taxable estate because the federal estate tax exemption is at an all-time high. For 2023, the Federal combined estate and gift tax exemption is $12.92 million. This means that during your lifetime and at death you can leave up to that amount to anyone you wish estate tax free. Any gifts made in excess of the federal exemption are taxed at 40%. New York State also has an estate tax but no gift tax. In 2023, a New Yorker’s entire estate is taxed up to 16% if the deceased’s estate tax exemption is above $6.54 million.

Will You Have a Taxable Estate in 2026?

However, the federal exemption is set to sunset in 2026 and revert to its pre-2018 level adjusted for inflation. The newest forecasts predict that the exemption will be between $5.5 and $6.8 million in 2026. For those individuals who have a taxable estate now or potentially will after 2026, an ILIT is a great option to minimize estate tax exposure.

How Does a Life Insurance Trust Work?

If you own a life insurance policy in your own name, the death benefit becomes part of your gross estate for federal and state estate tax purposes.  This does not save you any estate taxes but instead increases your gross estate and thus tax liability. But if an ILIT owns the life insurance policy, the death benefit is not part of your estate and passes free from estate tax. You would still be the insured under the life insurance policy and the death benefit passes to your chosen beneficiaries just like with a personally owned life insurance policy.

How could this be? The trust is the owner on the policy not you and you give up all control or “incidents of ownership.” But you can gift assets each year to the trust to pay the premiums using your annual gift tax exclusion, which is currently $17,000 per donee. This annual gift tax is not counted toward your federal lifetime gift tax (currently $12.92 million). The beneficiaries must be provided with a letter indicating their right to withdraw this gift – but usually see the benefit of letting the gift pay the life insurance premium!

Beware the Three-Year Rule

It is also important to remember that the IRS imposes a three year claw back rule on transfers made within three years of death. This means that any gifts made within 3 years of death are includable in a decedent’s estate for purposes of determining estate tax. This is to prevent the wealthy from making death bed gifts to avoid estate tax. For this strategy to work you must outlive the transfer of the life insurance policy to the ILIT by 3 years. Otherwise, the value of the policy will still be included in your gross estate. However, if the trust purchases the life insurance policy directly or pays fair market value for the existing policy, this rule does not apply.


A life insurance trust is an indispensable estate planning tool for wealthy individuals. As is the case with more complex estate planning tools, you will need an experienced trust and estates attorney to set up your trust.  For an ILIT to be effective, the trust must be drafted correctly. The trust must be irrevocable, the grantor cannot be the trustee and the trust must be created three years prior to death. If not drafted and administered correctly, an ILIT can fail and the death benefit become part of your estate.

Burner Law Group, P.C.

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