The irrevocable life insurance trust or "ILIT" has long been a mainstay of estate tax planning. It allows the taxpayer to shelter life insurance proceeds from the estate tax by removing them from her taxable estate. It has become much less commonly used as the federal estate tax threshold has moved up to $11.7 million, but will be of interest to more people as we get closer to 2026 when the threshold is slated to be cut in half. And, of course, the threshold is just $1 million in Massachusetts.
A Short Primer on ILITs and Crummey Powers
Here's how it works: You create an ILIT and either transfer an existing life insurance policy into it (in which case you need to survive three years for the trust to work) or the ILIT purchases a new policy on your life (in which case there's no waiting period).
The planning challenge is that if you pay the premiums yourself or transfer funds to the trust to pay the premiums, such payments would normally be taxable gifts. This would reduce the efficacy of the trust because every dollar of taxable gift you make during your life reduces the amount you can give away tax free at your death by that same dollar.
In other words, if during your life you make $100,000 of payments to the trust to pay the life insurance premiums, at your death the amount you can pass tax free to your heirs will be reduced by that same $100,000. Presumably, the tax free life insurance proceeds will be far more than your premium payments, so there would still be a benefit to the ILIT, just less of one.
In order to avoid the gift tax, ILITs include what are called Crummey powers, named after the case that approved their use. These powers permit beneficiaries of the trusts to remove funds transferred into them usually for a period of 30 days. This right is sufficient for the gifts to be treated as personal to the beneficiaries and as a result to qualify for the $15,000 per recipient annual gift tax exclusion.
In order for the Crummey powers to be effective, the trustee must have proof that the beneficiaries were aware of their right. This involves sending out so-called Crummey notices to the beneficiaries whenever funds are transferred to the trust.
The Reasons ILITs are Not for Everyone (or for Hardly Anyone)
With this background, we can discuss my three reasons why most people shouldn't consider setting up an ILIT:
- You (probably) don't have a federally taxable estate. While the Massachusetts estate tax kicks in at $1 million ($2 million for a couple with standard estate tax planning), currently the threshold for the federal estate tax is $11.7 million ($23.4 million for a couple). Even when these thresholds drop in half in 2026, less than 1% of households in the United States will have this much wealth. While those that do face a 40% estate tax on dollars above the threshold, the Massachusetts estate tax rates are much lower, ranging from about 7% for estates totaling $2 million to 16% for estates above $10 million. (You can read more about he Massachusetts estate tax here.) So, the estate tax savings of removing assets from your estate are much smaller on the state side than with respect to federal tax planning.
- Crummey powers are a total pain in the neck. Having to give notice to beneficiaries every time the trust is funded as well as keeping records that this has happened is a burden on the trustee. If the trustee is not a professional, there's a good chance that the notices will not be given or that the trustee won't maintain reliable records. If you engage an attorney or accountant to carry this out, there will be an extra cost. If the attorney does the rest of the work and helps maintain many ILITs for many clients, this will probably be done systematically at a low cost. But it's a difficult burden for a professional to take on for a few clients and the cost is likely to be higher.
- Most life insurance policies lapse. Term insurance is much less expensive than whole life insurance because most policy owners either outlive the term or allow the policies to lapse. Further, most people buy term insurance to insure their families while they are young. This means that if worse comes to worse and the owner dies during the policy's term, there's a good chance that the person's spouse will survive,
meaning there's no immediate estate tax, and the funds will be spent down paying to support your family. For example, let's say you purchase $1 million of term insurance with the premiums fixed for 20 years to make sure that if you die your spouse will have enough funds to put your children through college. If you then die during those 20 years and the insurance pays out, your spouse will likely use up the funds before his death paying to support the family. So, if you're going to buy insurance in order to create a legacy for your family, it should be a whole life policy, which will be expensive.
- ILITs crowd out other gifts to family. Remember that if you give anyone more than $15,000 during a calendar year ($30,000 for a couple), you need to file a gift tax return reporting the excess. If you're using up some of this amount by transferring funds to an ILIT, it reduces the amount you can give to your beneficiaries now. They may well need the funds more now when you are alive, and they are younger, than later when you are gone and they'll be inheriting a sizeable amount in any case. (Or why would be be considering setting up an ILIT?)
While ILITs made a lot of sense for a lot of people when the threshold for the federal estate tax and its higher tax rates was $1 million, very few taxpayers should give them serious consideration today. The cost and trouble of creating and administering them over the years is likely to far outweigh the ultimate tax savings.