How to Set Up an Irrevocable Life Insurance Trust (ILIT)

Setting up an Irrevocable Life Insurance Trust (ILIT) is a multi-step process that requires coordination between an estate planning attorney, a licensed insurance agent, and potentially a tax advisor. The ILIT is a powerful estate planning tool that removes the life insurance death benefit from your taxable estate while providing structured distribution to your beneficiaries. When properly established, an ILIT can shelter millions of dollars in death benefit proceeds from estate tax.

Step one is to work with an estate planning attorney to draft the ILIT document. This document establishes the trust, names the trustee (who administers the trust), designates the beneficiaries, and specifies the distribution terms. The trust must be truly irrevocable — once created, you cannot change its terms or reclaim the assets without the beneficiaries' consent. The trust document should include provisions for trustee succession, trust protector powers, distribution standards, and administrative procedures.

Step two is to appoint a trustee. This can be a trusted family member, a friend, a professional trustee, or a corporate trustee (bank or trust company). The trustee's role is to apply for the policy, pay premiums, file any required tax returns, send Crummey notices (see below), and ultimately distribute the death benefit according to the trust terms. Selecting the right trustee is critical — they must be responsible, financially literate, and willing to fulfill the ongoing administrative duties for what may be decades.

Step three is to have the trustee apply for and purchase the life insurance policy. Critically, the ILIT — not you — should be the original owner and beneficiary of the policy. This avoids the three-year lookback rule (IRC Section 2035) that applies when you transfer an existing policy to a trust. If the trust applies for and owns the policy from day one, the three-year rule does not apply because the insured never owned the policy. The insured cooperates with the application and medical exam but never has ownership rights.

Step four involves funding the trust through annual gifts. You gift money to the trust, and the trustee uses those funds to pay premiums. To qualify for the annual gift tax exclusion ($18,000 per recipient in 2024), the trustee must send Crummey notices to trust beneficiaries, giving them a limited window (typically 30-60 days) to withdraw the gifted funds. The beneficiaries' right to withdraw — even though they rarely exercise it — converts the gift from a future interest to a present interest, qualifying it for the annual exclusion.

Step five is ongoing administration: the trustee pays premiums, sends annual Crummey notices, files trust tax returns if required, and manages the trust assets. Upon the insured's death, the trustee files the death claim and distributes proceeds according to the trust terms. The ongoing administration is not overly burdensome but must be done consistently and properly documented — failure to send Crummey notices, for example, can disqualify gifts from the annual exclusion and create unintended gift tax liability.

The cost of establishing an ILIT includes attorney fees for drafting the trust document (typically ranging from illustratively $2,000 to $5,000 depending on complexity), ongoing trustee fees if a professional or corporate trustee is used, and the insurance premiums themselves. These costs should be weighed against the potential estate tax savings, which can be substantial for estates above the federal exemption threshold. For a $5 million death benefit, the estate tax savings from ILIT ownership at a 40% rate would be $2 million — far exceeding the cost of establishing and maintaining the trust.

Common mistakes in ILIT planning include the insured retaining incidents of ownership (even inadvertently), failing to send proper Crummey notices, underfunding the trust so premiums cannot be paid, selecting a trustee who does not fulfill their responsibilities, and failing to coordinate the ILIT with the overall estate plan. Working with experienced professionals minimizes these risks.