How to Use an Irrevocable Life Insurance Trust in Your Estate Plan

life insurance, irrevocable trusts, financial planning

Savvy investors keep one eye on Wall Street and one eye on Washington.

One of the main topics of Capitol Hill conversations is estate taxes, specifically annual and lifetime exemption amounts. Estate taxes often take aim specifically at the high net worth crowd, who have more to pass on.

Irrevocable Life Insurance Trusts (ILITs) are an important tool that financial advisors use to help with legacy tax planning, and we may see them come back in vogue, especially if the lifetime gift tax exemption rate goes down dramatically.

Let’s look at ILITs, from what they are to how they could be advantageous in the coming economy.

What is an Irrevocable Life Insurance Trust, or ILIT?

To use an irrevocable life insurance trust, an individual will take out a life insurance policy on themselves with their heirs as beneficiaries, and put the policy into an irrevocable trust so that estate taxes won’t touch it.

While the individual is still alive, they take advantage of the annual gift tax exemption to pay the premiums on these life insurance policies.

The premium payments are considered a “gift” to the beneficiaries and so can fly under the radar of the annual exemption. Year over year, a fair amount of a person’s estate can be moved into this trust, several thousand dollars at a time.

ILIT in Action

Say you inherit and run a chain of successful businesses and have an estate worth $10 million. You want to keep working until full retirement age, so you expect to grow your estate substantially in the coming decades.

Your advisor might recommend an ILIT as a way to help pass on your substantial estate without losing too much to taxes in the transfer. So, you take out life insurance policies and put them into an irrevocable trust. These assets will stay outside of the estate as long as your death does not occur inside of three years, due to the clawback provision on your policies.

Right now, in 2021, the lifetime exemption amount is $11.7 million for an individual or $23.4 million for a couple. If you pass on more than this through your estate, you could pay taxes as high as 40%.

The annual gift tax exemption right now is $15,000 per person, per recipient. So, if you have three children, you can give $45,000 per year, up to a total of $90,000 for both parents. You can use this gifted money to cover the premiums for your life insurance policies and send it directly to the trust.

In 30 years under this scenario, when you set out on a retirement cruise, you’ve funneled $2.7 million out of your estate, which can help with the overall inheritance taxes when the time comes.

You can also leave a $10 million death benefit ($5 million each) tax-free for the kids, which will help to pay any estate taxes and can cover funeral costs and other estate-settling charges. The ILIT, then, becomes an estate planning tool, allowing you to keep the estate you pass on intact.

The Crummey Letter

One of the important yearly boxes to check is to send each of your kids an annual Crummey Letter when you “gift” them the premium payment. Named after a famous court case involving Reverend Crummey, this annual letter legitimates that the annual sum you pay for the premiums is a gift and therefore belongs under the annual gift tax exemption.

The Crummey Letter is sent every year and gives the recipient a window of time to claim the money (usually 30 to 60 days), before rendering it to the trust if the recipient does nothing. Talk to your kids about the importance of allowing the money to go into the trust if that’s your wish, but this step is still a legal requirement.

Changes to the Lifetime Exemption Through the Years

As we’ve seen, the lifetime exemption amount is remarkably high right now, and it’s not something we should assume will survive a change in administration or the test of time. A short look back shows us the volatility of these rates, as well as the estate tax rate. Here are a few examples:

Year  Gift Tax Exemption  Top Gift Tax Rate 
2001 $675,000 55%
2005 $1 million 47%
2011 $5 million 35%
2018 $11.18 million 40%
2021 $11.7 million 40%


As you can see, this potential political lighting rod has made for regular changes in the past, and that trend is likely to continue. President Joe Biden has been vocal about a plan to reduce the lifetime exemption amount to as low as $3.5 million. Even if Biden’s plan doesn’t move forward, the Tax Cuts and Jobs Act will sunset in 2026, and the limit will come back down to $5 million.

If the limit trends lower again, most likely we can expect to see a revival of ILITs. Many of us aren’t too worried about hitting the $11.7 million ceiling, especially when it’s doubled with our spouse, but what if that limit is $3.5 million? A young professional with a healthy 401(k) and a few promotions in his/her future could hit that limit without much trouble.

Planning for Financial Changes Ahead

If the history of estate tax planning shows us anything, it’s that the goalposts move often and sometimes with little warning. Think of 1981, in Reagan’s America, when the lifetime exemption was $175,000 – or roughly half a million in today’s dollars – and the estate tax rate went up to 70%!

Check in with your financial advisor about your options and set up a timeline for when an ILIT would be to your advantage.

How can we help you? Our advisors have their eye on Washington and Wall Street and can help you optimize your financial plan. Get in touch today to start the conversation.

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