An irrevocable life insurance trust (ILIT) is an estate planning tool where a trust, rather than the insured individual, owns a life insurance policy. By transferring ownership of the policy to the ILIT, the death benefit is removed from the insured's taxable estate, potentially saving the estate from federal estate taxes. The trust is "irrevocable" because once established, the grantor (the person creating the trust) gives up control of the policy and the terms of the trust generally cannot be changed. This relinquishment of control is what makes the estate tax exclusion possible — if the grantor retained control, the IRS would include the death benefit in the taxable estate.
The primary purpose of an ILIT is to keep the life insurance death benefit out of the insured's estate for federal estate tax purposes. Under current law, if you own a life insurance policy at the time of death, the full death benefit is included in your taxable estate. For estates approaching or exceeding the federal exemption ($13.61 million per individual in 2024), this inclusion could trigger significant estate taxes at rates up to 40%. By having the ILIT own the policy, the death benefit passes to the trust beneficiaries free of both income tax and estate tax. The potential tax savings can be substantial — on a $2 million death benefit in an estate above the exemption, the estate tax savings could be an illustrative $800,000 at the 40% rate.
Setting up an ILIT involves creating the trust document with an estate planning attorney, naming a trustee to manage the trust (this should not be the insured, as serving as trustee could be interpreted as retaining incidents of ownership), and either having the trust purchase a new policy or transferring an existing policy to the trust. If an existing policy is transferred, there is a three-year lookback period — if the insured dies within three years of the transfer, the death benefit is still included in the estate. This lookback rule makes it preferable to have the ILIT purchase a new policy when possible, avoiding the three-year risk entirely.
Premiums are typically funded through annual gifts from the grantor to the trust. These gifts must qualify as present-interest gifts to use the annual gift tax exclusion ($18,000 per beneficiary in 2024). To achieve this qualification, the trustee sends "Crummey letters" to trust beneficiaries, notifying them of their right to withdraw the gift amount for a limited period (typically 30 to 60 days). While beneficiaries rarely exercise this withdrawal right, the notice is legally required to establish the present-interest nature of the gift. Without proper Crummey notices, the gifts may not qualify for the annual exclusion, potentially consuming the grantor's lifetime gift/estate tax exemption.
A common misconception about ILITs is that they are only relevant for ultra-wealthy families. While ILITs are most commonly used by families with estates approaching or exceeding the federal exemption, they can also be valuable for families below the current threshold who are concerned about potential future decreases in the exemption amount. The current elevated exemption is scheduled to potentially decrease, and families who establish ILITs now may benefit from having the structure already in place if the exemption drops significantly.
ILITs require ongoing administration, including annual Crummey notices, premium payments, trustee duties, trust tax return filing (Form 1041), and record-keeping. The costs of establishing and maintaining an ILIT (attorney fees, trustee fees, annual administration costs) should be weighed against the potential estate tax savings. For Tennessee residents, the absence of a state estate tax means ILITs are primarily relevant for addressing federal estate tax exposure. However, Tennessee's favorable trust laws make the state an attractive jurisdiction for ILITs that serve families across multiple states.
The selection of a trustee is a critical decision in ILIT administration. The trustee is responsible for managing the trust's assets, making premium payments, sending Crummey notices, filing tax returns, and eventually distributing the death benefit according to the trust terms. The trustee should be someone trustworthy, financially capable, and willing to fulfill the ongoing administrative requirements. Options include a family member, a trusted friend, a professional trustee, or a corporate trust company. The insured cannot serve as trustee, and many estate planners recommend against naming the insured's spouse to avoid any appearance of retained control.
Tennessee's favorable trust laws provide additional benefits for ILITs. The state allows perpetual trusts (dynasty trusts), which can keep the death benefit in trust for multiple generations, avoiding estate tax at each generational transfer. The Tennessee Trust Code provides flexibility for trust modification and administration, and the state's directed trust statute allows separate investment and distribution advisors. Guarantees on the underlying life insurance policy are backed by the financial strength and claims-paying ability of the issuing carrier.