Many people are surprised to learn that, while life insurance payouts are not considered taxable income for your beneficiaries, they can be subject to estate taxes, depending on who owns the policy at the time of your death.
In Massachusetts, if your estate exceeds $2 million, including the value of your life insurance policy, your heirs may face a significant estate tax bill. That means if you have a life insurance policy and other assets like a home, retirement accounts, or investments, estate tax planning may be more important than you thought.
Enter the Irrevocable Life Insurance Trust (ILIT)
An ILIT is a specialized trust designed to own your life insurance policy outside of your taxable estate. By placing the policy in an ILIT, the death benefit can pass to your loved ones without being counted toward your estate’s value—potentially saving them tens of thousands in estate taxes.
How it works. If the life insurance policy already exists in your name, you can transfer it to an ILIT, but you’ll need to survive at least three years after the transfer for it to be fully excluded from your estate. On the other hand, if the ILIT is set up before the policy is issued, the death benefit is excluded from day one.
Important limitations. To keep the ILIT effective for estate tax purposes:
- You shouldn’t serve as trustee, nor should your spouse or children (if they’re also the beneficiaries).
- You can’t retain any economic benefit from the policy, meaning no borrowing against it or accessing the cash value after it’s transferred.
- The ILIT, not you, must pay the policy premiums. This is typically done by gifting money to the trust, which the trustee then uses to pay the insurer.
To avoid gift tax issues, the trustee usually sends Crummey notices to the beneficiaries, giving them a temporary right to withdraw the gift. It’s a key step that makes the gift qualify for the annual gift tax exclusion.
What kind of insurance can go into an ILIT? You can use either term insurance (coverage for a set number of years) or permanent insurance (which lasts for life and builds cash value). Just remember, once the policy is inside the ILIT, you give up access to that cash value.
Why it matters. Without this type of planning, your family might end up using part of their inheritance to pay estate taxes—even though you purchased life insurance to protect them financially. An ILIT offers a way to preserve more of your legacy and ensure your wishes are carried out effectively.
Is an Irrevocable Life Insurance Trust right for you?
An ILIT can be a powerful tool—but it’s not for everyone. It requires careful setup, strict adherence to rules, and thoughtful long-term management. If you’re considering a significant life insurance policy or are concerned about estate taxes, we’d be happy to help you explore whether this option fits into your broader estate plan. Contact one of our Trust and Estate Attorneys to schedule a conversation.
