Irrevocable life insurance trusts

What it's for

• Keeping a death benefit outside the taxable estate
• Controlling when and how beneficiaries receive money
• Providing estate liquidity without adding to the estate
• Protecting a beneficiary who shouldn't receive a lump sum directly
• Keeping arrangements private, since trusts generally avoid probate

The three-year rule

Transferring an existing policy into a trust doesn't take immediate effect for estate purposes. If the insured dies within three years of the transfer, the death benefit is generally pulled back into the estate.

The implication is practical: it's usually cleaner for the trust to apply for and own a new policy from the outset. If a transfer is the only route, do it as early as possible.

Funding it, and the notices

Premiums are typically funded by gifts to the trust. For those gifts to qualify for the annual gift tax exclusion, beneficiaries generally need a temporary right to withdraw — which is why trustees send withdrawal notices, commonly called Crummey notices, each time a gift is made.

Skipping those notices is one of the most common administrative failures in these trusts, and it can undermine the tax treatment the structure was built for. If you have an ILIT, ask your trustee whether the notices have actually been sent, every year.

Retaining control defeats it

The trust has to be genuinely irrevocable and genuinely administered by the trustee. Retaining the ability to change beneficiaries, borrow against the policy, or direct the trustee can bring the death benefit back into your estate.

That's the trade at the heart of the structure: you give up control to get the treatment. Half-measures produce the costs of both approaches and the benefits of neither.

The ongoing obligations

• A trustee who actually acts as trustee, and who isn't you
• Gifts made properly, and withdrawal notices sent and documented
• A separate trust bank account, with premiums paid from it
• Gift tax returns where required
• Periodic review of the policy itself, including in-force illustrations

When it isn't worth it

Federal estate tax affects a small minority of estates, and the thresholds change. If your estate is well below the level where it applies and your state has no separate tax at a lower threshold, the administration may cost more than it saves.

Naming beneficiaries directly, or using a simpler trust, may serve better. That's a conversation with an estate attorney about current figures, not a decision from a general article.