How an Irrevocable Life Insurance Trust Can Reduce Your Estate Taxes
What Is an Irrevocable Life Insurance Trust?
An ILIT is a specific type of trust designed to hold a life insurance policy outside of your taxable estate. Because it is irrevocable, once you create it, you generally cannot change or dissolve it — so you need to plan carefully before setting one up.
How an ILIT Works
- Create the trust.
Work with an estate planning attorney to establish the irrevocable trust. - Fund the trust with a life insurance policy.
You can either:- Purchase a new life insurance policy directly in the name of the trust, or
- Transfer an existing policy into the trust.
- Keep the policy outside your estate.
Because the trust owns the policy — not you — the death benefit is not included in your taxable estate when you pass away. - Provide liquidity for your heirs.
The proceeds from the life insurance can be used to pay estate taxes or provide immediate funds to beneficiaries without the delays of probate.
Why This Matters for Estate Taxes
If you own a life insurance policy personally, the payout is included in your estate for tax purposes. For example, if you have a $1 million policy, that entire amount is added to your estate’s value when calculating taxes.
By transferring the policy into an ILIT, that $1 million is excluded from your estate — potentially saving hundreds of thousands in estate taxes and ensuring your heirs receive the full benefit.
When to Consider an ILIT
- You’ve already used other estate tax reduction strategies. An ILIT often comes into play after tools like a credit shelter trust have been set up.
- You live in a state with a lower estate tax exemption (such as Washington).
- You want to ensure liquidity for your heirs without increasing your estate’s taxable value.
The Bottom Line
An Irrevocable Life Insurance Trust is a relatively simple yet powerful way to reduce estate taxes and protect your life insurance payout from being diminished by the IRS or state tax authorities.
Because ILITs are permanent and can’t easily be undone, work with a qualified estate planning attorney to structure it correctly from the start.