By Stephen W. Bedikian, Associate Wealth Advisor
When the recently passed One Big Beautiful Bill Act permanently increased the estate tax exemption to $15 million per person – $30 million for married couples – it called into question the value of some classic estate planning strategies. The use of an irrevocable life insurance trust (ILIT pronounced ‘eye-lit’) is among these. This trust vehicle is designed to pass the value of a life insurance policy death benefit to heirs outside of an estate to avoid estate taxes.
As recently as 2008, the federal estate tax rate was 45% and the exemption amount was just $2 million. There was a much greater need for strategies to avoid the estate tax. Now, with the $15 million exemption per spouse made permanent, it’s estimated that less than 1% of families will be subject to the current 40% federal estate tax.
But it’s worth remembering that there is nothing permanent about the U.S. tax code. What is made permanent today can change with the next administration. You should also be aware that a number of states have their own estate taxes. In Washington state, for example, the estate exemption is only $2.193 million, with the estate tax rate reaching up to 20%.
What is genuinely permanent is making a decision to create an irrevocable trust and then paying the policy premiums for the life insurance policy to fund it.
What is an Irrevocable Life Insurance Trust?
Generally, an ILIT is funded with a whole life policy, which is a type of permanent policy: It remains in force until the death of the insured. Term life insurance is generally cheaper to purchase, but in terms of funding an ILIT, the risk that the insured person will outlive the term of the policy defeats the purpose of creating the trust. If the policy expires with no payouts, the expenses incurred are wasted.
Establishing an irrevocable trust usually requires several thousand dollars in legal fees upfront. A separate trust tax return may also need to be filed annually and may involve accounting fees. In addition, if the trust isn’t managed by a family member or a friend of the policy owner (in legal terms, the grantor), then a third-party corporate trustee will be required, thus incurring annual management fees.
How to set up an Irrevocable Life Insurance Trust
In order to move a life insurance policy out of their estate for tax purposes, the grantor must be willing to forgo ownership of the policy. The grantor typically contributes an existing policy into the trust or contributes cash to pay its annual policy premiums. A grantor can also use the gift tax exclusion to pay annual policy premiums (up to $19,000 in 2025). Other than funding it, they can have no control over the policy or the trust. They can’t act as the trustee, which would normally be the case with a revocable trust.
Given the inflexibility of an ILIT after it’s created and funded, one option you can consider is to purchase the life insurance policy and then decide later whether to contribute that policy into an irrevocable trust. Life insurance is priced based on age and other factors; typically, the cost is lower for younger applicants. But keep in mind that the IRS has a three-year lookback period for ILITs: A policy that is purchased or contributed within three years of the insured’s death will be included in the estate.
The potential benefits of whole life policies
A whole life policy can offer many benefits when held outside of an ILIT. For example, as a policyholder, you can take a loan from the policy at any time up to the amount of the accrued or cash value. The loan can be paid back or it can be left outstanding and paid off with the death benefit when you, the insured, pass away. A portion of the annual premium goes into the cash value account and grows at a guaranteed, tax-deferred rate. If the insurance company is a mutual or policyholder owned-company, you may also receive dividends. And of course, the death benefit is paid out income-tax free to your beneficiaries.
Irrevocable Life Insurance Trust pros and cons
Once that policy is contributed into an ILIT, financial flexibility is lost, and the purpose of the policy is strictly for your legacy. For those who work in professions with high financial or legal liability risk, the creditor protection offered by an irrevocable trust may provide peace of mind.
Unlike an auto or a homeowner’s policy, a life insurance policy can be in force for decades. Performing due diligence on the insurance company is essential. You should set your sights on purchasing a policy from a well-established, financially strong company.
Because an ILIT is funded with whole life insurance, there are a number of financial considerations: how much life insurance do I need? A whole life policy has a fixed income investment component so how will this affect the fixed income allocation of my existing investment portfolio? Is my portfolio projected to grow large enough in the future to require use of estate planning tools like an ILIT?
Explore whether an ILIT could be good for you
Deciding whether an ILIT is right for you requires weighing the benefits, costs, and long-term implications for your estate. While an ILIT can offer tax advantages, creditor protection, and a structured way to pass wealth to your heirs, it also limits access to the policy and requires careful planning.
A Halbert Hargrove advisor can help you to answer these questions and to help navigate your financial future. Reach out to us now.
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