ILITs and You
Please note: The following is for informational purposes only and does not constitute legal advice. We strongly recommend consulting an experienced estate planning attorney before making any decisions related to your estate plan.
Estate Planning and ILITs: A Strategic Tool for Tax Efficiency and Liquidity
Estate planning can feel overwhelming. The process often involves unfamiliar legal terms, complex strategies, and the uncomfortable topic of mortality. It's no surprise that many people either delay planning altogether or settle for a basic will or revocable trust. For the majority, a simple estate plan may be sufficient to ensure their assets pass to loved ones in accordance with their wishes.
However, for individuals with larger estates or specific liquidity concerns, a basic plan might not go far enough. In Massachusetts, if the value of everything you own or have an interest in exceeds $2 million, your estate may be subject to the Massachusetts estate tax, which must be paid within nine months of death. This includes real estate, bank and investment accounts, tangible personal property, and often, life insurance policies.
At the federal level, the estate tax exemption is significantly higher—$13.99 million per person in 2025. As a result, the federal estate tax is less of a concern for many Massachusetts residents, but the state-level tax can still have a significant financial impact.
Moreover, even if your estate is not subject to tax, your heirs could face serious challenges if your wealth is held in illiquid assets such as real estate, business interests, or limited partnerships. In these cases, the family may be forced to sell assets quickly—potentially at a loss—to pay taxes or expenses. This is where an Irrevocable Life Insurance Trust (ILIT) may provide a solution.
What Is an ILIT and How Does It Work?
An Irrevocable Life Insurance Trust, or ILIT, is a specialized trust designed to own and manage a life insurance policy outside of your taxable estate. Once you transfer a life insurance policy into the ILIT—or fund the ILIT so the trustee can purchase a policy—you relinquish control over the policy, and the ILIT becomes both the owner and beneficiary.
Here’s how it typically works:
• The grantor (you) establishes the ILIT and names a trustee (someone other than yourself).
• The ILIT purchases or receives a transfer of a life insurance policy on your life.
• You make periodic gifts of cash to the ILIT to fund premium payments.
• The trustee notifies the beneficiaries of their temporary right to withdraw the gift via Crummey notices, a necessary step to qualify the gift for the annual gift tax exclusion.
• Upon your passing, the life insurance proceeds are paid directly to the ILIT, where the trustee uses them to provide estate liquidity or distribute them to your beneficiaries, as outlined in the trust document.
Key Legal Considerations
An ILIT offers powerful benefits, but it must be structured and administered correctly to achieve its intended tax advantages.
1. Estate Tax Exclusion:
Life insurance held within an ILIT is excluded from your gross estate, which may reduce or eliminate state estate taxes that would otherwise apply to the policy’s death benefit.
2. Three-Year Rule (IRC §2035):
If you transfer an existing life insurance policy to the ILIT and pass away within three years of the transfer, the proceeds will be pulled back into your estate for tax purposes. This rule does not apply if the ILIT purchases the policy directly.
3. Gift Tax Compliance:
Contributions to the ILIT used to pay premiums are considered gifts. If the amount exceeds the annual exclusion of $19,000 per beneficiary in 2025, you may be required to file a gift tax return, and it could reduce your lifetime exemption.
4. Trust Administration:
While the administrative burden is manageable, it is not insignificant. The trustee must issue timely Crummey notices, manage a separate trust bank account, maintain detailed records, and follow all terms of the trust to preserve tax advantages.
Why Consider an ILIT?
For individuals with a taxable estate and significant life insurance coverage, or illiquid assets, an ILIT can:
• Reduce estate taxes by excluding policy proceeds from the estate.
• Provide liquidity to pay estate taxes or other obligations without forcing asset sales.
• Protect wealth for future generations through structured trust distributions.
Conclusion
An ILIT is not a one-size-fits-all solution, but it can be a highly effective estate planning strategy when used appropriately. With careful drafting, funding, and administration, an ILIT can help ensure that your legacy passes efficiently and tax-effectively to your loved ones.
If you’re considering incorporating an ILIT into your estate plan, we encourage you to speak with an estate planning attorney who can evaluate your specific situation and guide you through the process.