Irrevocable Life Insurance Trust (ILIT) in Florida

An irrevocable life insurance trust, commonly known as an ILIT, is an irrevocable trust specifically designed to own and be the beneficiary of a life insurance policy on the grantor's life. The primary purpose of an ILIT is to remove the life insurance proceeds from the insured's taxable estate, potentially saving hundreds of thousands or even millions of dollars in federal estate taxes. At the Law Offices of Albert Goodwin, PA, we help individuals and families throughout South Florida establish and administer ILITs as part of comprehensive estate tax planning strategies.

Why Life Insurance Can Create Estate Tax Problems

Many people assume that life insurance proceeds are not taxable. While it is true that life insurance death benefits are generally exempt from income tax under IRC § 101(a), they are not exempt from federal estate tax. Under IRC § 2042, the proceeds of a life insurance policy are included in the insured's gross estate if the insured possessed any "incidents of ownership" in the policy at the time of death. Incidents of ownership include the right to change the beneficiary, borrow against the policy, surrender or cancel the policy, assign the policy, or exercise any other economic control over the policy.

For a high-net-worth individual whose estate already exceeds or approaches the federal estate tax exemption, a large life insurance policy can push the estate further into taxable territory. For example, if an individual has a $10 million estate and a $5 million life insurance policy that they own personally, their gross estate at death would be $15 million. At a federal estate tax rate of 40 percent, the estate tax on the amount exceeding the exemption can be substantial. An ILIT eliminates this problem by ensuring that the insured never possesses incidents of ownership in the policy.

How an ILIT Works

The basic structure of an ILIT involves the following steps:

Creating the trust. The grantor establishes an irrevocable trust that is specifically designed to hold life insurance. The trust document names a trustee (who should be someone other than the insured), identifies the trust beneficiaries (typically the grantor's spouse, children, or other family members), and sets forth the terms under which trust assets will be managed and distributed after the insured's death.

The trust acquires the policy. The ILIT either purchases a new life insurance policy on the grantor's life or the grantor transfers an existing policy to the trust. If a new policy is purchased, the trust applies for and owns the policy from inception, which avoids the three-year rule discussed below. The trust is named as both the owner and the beneficiary of the policy.

Funding the premiums. Because the trust is irrevocable and the grantor has relinquished all control, the grantor cannot simply pay the premiums directly. Instead, the grantor makes gifts to the trust, and the trustee uses those gifts to pay the premiums. These gifts must be structured carefully to qualify for the annual gift tax exclusion through Crummey notices.

Policy proceeds at death. When the insured dies, the life insurance company pays the death benefit to the ILIT as the policy beneficiary. Because the insured did not own the policy and had no incidents of ownership, the proceeds are not included in the insured's gross estate. The trustee then manages and distributes the proceeds according to the trust terms.

Crummey Notices: Making Premium Payments Tax-Free

One of the most critical administrative requirements of an ILIT is the Crummey notice, named after the landmark case Crummey v. Commissioner. The annual gift tax exclusion (currently $19,000 per recipient in 2025, indexed for inflation) applies only to gifts of a "present interest," meaning the donee must have an immediate right to use or enjoy the gifted property. A contribution to an irrevocable trust is generally a gift of a future interest, which does not qualify for the annual exclusion.

To convert contributions to the ILIT into present interest gifts, the trust document must include a Crummey withdrawal power, which gives each trust beneficiary a temporary right to withdraw their share of each contribution. Each time the grantor makes a contribution to the trust (typically to fund the annual premium payment), the trustee must send written Crummey notices to each beneficiary informing them of their right to withdraw their proportionate share of the contribution. The beneficiary must have a reasonable period, typically 30 days, to exercise the withdrawal right. In practice, beneficiaries almost never exercise this right because doing so would defeat the purpose of the trust, but the legal right must exist and the notice must be properly given.

If the trustee fails to send Crummey notices, the contributions to the trust will not qualify for the annual gift tax exclusion, and the grantor will need to use their lifetime gift tax exemption to cover the gifts or pay gift tax. Proper documentation and consistent administration of Crummey notices is essential throughout the life of the trust.

The Three-Year Rule: IRC § 2035

If the grantor transfers an existing life insurance policy to the ILIT and dies within three years of the transfer, the policy proceeds will be included in the grantor's gross estate under IRC § 2035, as if the transfer had never been made. This three-year rule is one of the most important traps in ILIT planning and underscores the importance of establishing the ILIT as early as possible.

To avoid the three-year rule entirely, the preferred approach is to have the ILIT apply for and purchase a new life insurance policy from the outset, rather than transferring an existing policy. When the trust is the original owner and applicant for the policy, the insured never possesses any incidents of ownership, and the three-year rule does not apply regardless of when the insured dies.

If transferring an existing policy is the only practical option (for example, if the insured is no longer insurable), the grantor and their advisors must be aware that the transfer triggers the three-year lookback period. Some planners recommend purchasing additional term insurance to cover the potential estate tax liability during the three-year period, providing a safety net in case the insured dies before the lookback period expires.

ILIT Funding Strategies

The most common funding mechanism for an ILIT is annual gifts from the grantor to the trust, coordinated with Crummey notices, to cover the annual premium payments. For policies with relatively modest premiums, the grantor can often cover the entire premium through annual exclusion gifts. For example, if the trust has four beneficiaries and the annual exclusion is $19,000 per beneficiary, the grantor can contribute up to $76,000 per year to the trust without using any lifetime exemption (or $152,000 if the grantor's spouse consents to gift-splitting).

For policies with larger premiums, such as second-to-die policies or large whole life policies, additional funding strategies may be needed. The grantor may use a portion of their lifetime gift tax exemption to make larger contributions, or the trust may be structured to hold income-producing assets in addition to the life insurance policy, with the income used to pay premiums.

Some ILITs are combined with other estate planning vehicles. For example, a grantor trust structure can be used so that the grantor pays income taxes on any trust investment income, allowing the trust to retain more assets for premium payments. An ILIT can also be coordinated with a family limited partnership or other wealth transfer vehicle to create a comprehensive estate plan.

ILIT Administration

Ongoing administration of an ILIT requires careful attention to several important tasks. The trustee must send Crummey notices each time a contribution is made. The trustee must pay premiums on time to prevent the policy from lapsing. The trustee should periodically review the policy's performance, particularly for cash value policies, to ensure that the policy remains adequately funded and that the death benefit is sufficient for the estate plan's objectives.

The trustee must also file annual trust income tax returns (Form 1041) if the trust has any taxable income, such as interest on cash held in the trust account between contributions and premium payments. The trustee should maintain complete records of all contributions, Crummey notices, premium payments, policy statements, and correspondence with the insurance company.

After the insured's death, the trustee's responsibilities shift to collecting the death benefit, managing the proceeds according to the trust terms, and making distributions to beneficiaries. The trust may direct outright distributions, continued management of the proceeds in trust, or a combination of both. Many ILITs provide for staggered distributions to beneficiaries at specified ages or milestones, or give the trustee discretion to distribute funds based on the beneficiaries' needs.

ILIT and Florida Estate Planning

Florida's lack of a state income tax makes ILIT planning particularly attractive for Florida residents. The trust's investment income (to the extent there is any) is not subject to state income tax, and the grantor's income is not reduced by state taxes on trust earnings. Additionally, Florida's absence of a state estate tax means that ILIT planning focuses entirely on federal estate tax savings.

An ILIT should be coordinated with the insured's overall estate plan, including their revocable living trust, will, beneficiary designations, and other planning documents. The ILIT can provide liquidity to pay estate taxes, debts, and administrative expenses without forcing the sale of illiquid assets such as real estate or business interests. This liquidity function is particularly valuable for individuals whose wealth is concentrated in non-liquid assets.

Contact a Florida ILIT Attorney

An irrevocable life insurance trust is one of the most effective tools for removing life insurance proceeds from your taxable estate and preserving wealth for your family. However, ILITs require careful drafting, proper funding, and diligent ongoing administration. At the Law Offices of Albert Goodwin, PA, we guide clients through every step of the ILIT process, from trust creation to policy acquisition to annual administration. Our office is located at 121 Alhambra Plz #1000, Coral Gables, FL 33134. Call us at 786-522-1411 or email us at [email protected] to discuss how an ILIT can protect your family's financial future as part of your estate plan.