ILIT (Irrevocable Life Insurance Trust) in New York

Life insurance you own is part of your taxable estate, and in New York it is often the asset that tips a family over the cliff. This page covers how an ILIT keeps the proceeds out and how the trust is funded and reported.

Clients are often surprised that life insurance counts toward their estate. It is not an asset they can spend, and the proceeds are income-tax-free to the beneficiary. But a policy you own on your own life is included at its full face amount the moment you die. A New York family with a house, retirement accounts and a couple of million dollars of term insurance can be over the state’s $7,350,000 exclusion without ever feeling wealthy.

An irrevocable life insurance trust, or ILIT, is the fix. The trust, not you, owns the policy and receives the proceeds. If it is set up and run correctly, the death benefit is outside both the federal and the New York gross estate, and the trustee can use it to pay whatever tax the rest of the estate owes. This page focuses on the tax mechanics and on how an ILIT interacts with New York’s cliff; for a general overview of the trust, see our page on irrevocable life insurance trusts in New York.

Why life insurance is in your taxable estate

IRC § 2042 includes in the gross estate the proceeds of any policy on the decedent’s life that are payable to the estate, and the proceeds of any policy over which the decedent held an “incident of ownership” at death. Incidents of ownership include the power to change the beneficiary, surrender the policy, borrow against the cash value, or assign or pledge it. A decedent who has given the policy away but kept any of those powers is still caught.

New York starts from the federal gross estate, so anything § 2042 pulls in is in the New York estate too. That matters because of the cliff (Tax Law § 952). A New York taxable estate up to $7,350,000 pays nothing in 2026. An estate of $7,717,500 loses the credit entirely and pays about $735,000. Between those two figures the effective marginal rate approaches 200%. Insurance is uniquely dangerous here because it arrives all at once, at death, at face value. A $1,000,000 policy on a $7,000,000 estate moves the estate from paying nothing to paying on every dollar. Our cliff page and the cliff calculator show the arithmetic.

How an ILIT removes the policy

The ILIT is an irrevocable trust with a trustee other than the insured. The trustee applies for and owns the policy, is named as its beneficiary, and holds every incident of ownership; the insured holds none and is not a trustee. At death the trustee collects the proceeds and holds or distributes them under the trust terms. Because the insured never held an incident of ownership in a policy the trust bought, § 2042 does not apply, the proceeds are outside the federal gross estate, and New York follows.

The spouse can be a discretionary beneficiary of the ILIT. That gives the family indirect access during the survivor’s life without inclusion in the survivor’s estate at the second death, which is where New York’s lack of portability bites. An ILIT for a married couple is, in that sense, a credit shelter trust funded with insurance.

Transferring an existing policy: the § 2035 three-year rule

Clients who already own a policy want to move it into the trust. IRC § 2035 includes in the gross estate any life insurance the decedent transferred within three years of death. Assign the policy to the ILIT, die two years later, and the entire death benefit is back in the estate, and therefore in the New York estate, as if the trust did not exist.

• Have the trust buy a new policy where possible. If the insured is insurable, the trustee should apply for a new policy in the trust’s name from the outset. A policy the trust bought was never transferred, and § 2035 has nothing to attach to.
• If the existing policy must be moved, move it now. The three years run from the assignment. A low-premium old policy or a health change that makes new coverage expensive is the usual reason to accept the risk.
• The transfer itself is a gift. The gift is measured by the policy’s value at the time, roughly its interpolated terminal reserve for a permanent policy or the unearned premium for term insurance. If it exceeds $19,000, it is a taxable gift reported on Form 709 and is itself subject to New York’s three-year add-back, though a policy already included under § 2035 is excepted from a second inclusion.
• Selling the policy to the trust for full value avoids § 2035 because it is not a gift, but the trust needs money and the transfer-for-value rules must be handled with care.

Paying premiums: Crummey powers, annual exclusion gifts and the 5-and-5 problem

The trust needs cash each year to pay the premium, and the insured gives it. A gift to a trust is normally a future interest that does not qualify for the $19,000 annual exclusion, so every premium would eat exemption and be reportable. The solution, from Crummey v. Commissioner, 397 F.2d 82 (9th Cir. 1968), is to give each beneficiary a temporary right to withdraw his or her share of each contribution. The withdrawal right makes the gift a present interest, and the annual exclusion applies. Our Crummey trust page covers the mechanics.

In 2026 the exclusion is $19,000 per beneficiary, or $38,000 if the insured’s spouse consents to split the gift on a Form 709. Three children as Crummey beneficiaries shelter $57,000 of premium a year, or $114,000 with gift-splitting. The trustee sends written notice of each contribution; the beneficiaries let the right lapse, and the money stays in the trust to pay the premium.

The lapse creates a second problem. Under IRC § 2514(e) and § 2041(b)(2), a beneficiary who lets a withdrawal right lapse has made a gift to the trust to the extent the lapsed amount exceeds the greater of $5,000 or 5% of the trust’s assets. An ILIT holding a term policy has little in it, so 5% is small and a $19,000 lapse exceeds $5,000. The fix is a “hanging power”: the excess over the 5-and-5 amount carries forward and lapses in later years as the limit allows. Without it, each child quietly makes taxable gifts to the trust every year.

When a Form 709 is still advisable

If every contribution is covered by Crummey powers within the annual exclusion, no Form 709 is required. We still recommend one in three situations. First, gift-splitting under § 2513 requires both spouses to consent on a return, even if the split gifts fit within the exclusion. Second, any year in which contributions exceed the exclusions, or in which the existing policy is transferred, produces a taxable gift that must be reported by April 15 of the following year.

Third, and most often overlooked, a dynasty-style ILIT with grandchildren as beneficiaries needs GST exemption allocated to it. The gift tax annual exclusion does not automatically shelter a trust gift from GST tax, and the automatic allocation rules of § 2632(c) do not always produce the result the family wants. A Form 709 that affirmatively allocates GST exemption to each contribution keeps the inclusion ratio at zero, so the proceeds can pass to grandchildren free of the 40% GST tax. Our Form 709 page covers the filing rules and the GST trust page covers the allocation.

The ILIT as a source of estate liquidity

Removing the policy is half the benefit. The estate still has to pay tax on everything else nine months after death, and a New York estate is often a house, a co-op, a business or retirement accounts rather than cash. The ILIT can supply the cash without putting the proceeds back in the estate, if the document is drafted correctly.

• The trustee may buy assets from the estate at fair market value, giving the executor cash to pay the tax and keeping the real estate or business in the family.
• The trustee may lend to the estate on commercial terms, secured by estate assets.
• The trustee must never be required to pay the estate’s taxes or debts. Proceeds that the executor can compel are treated as receivable by the estate and included under § 2042. The power must be discretionary, and the trustee should exercise it as an investment decision.

For married couples, a second-to-die (survivorship) policy fits this role well. The marital deduction defers all tax until the survivor dies; that is when the New York tax, with no portability of the first spouse’s exclusion, comes due on the combined estate. A survivorship policy in an ILIT pays out exactly then, at lower premiums than two single-life policies.

Trustee selection

The insured cannot be trustee. A spouse who is also a beneficiary can serve, but a spouse-trustee with discretion over distributions to himself or herself creates § 2041 problems; we limit any spouse-trustee to an ascertainable standard or add an independent co-trustee. The duties are administrative but unforgiving: send the Crummey notices, pay the premium on time, keep the trust’s own bank account, and never let the insured pay the carrier directly. A reliable adult child, a trusted advisor or a corporate trustee are the usual choices, with a named successor.

New York-specific points

Proceeds are not in the New York gross estate

New York’s estate tax is computed from the federal gross estate. Insurance that § 2042 leaves out of the federal estate is out of the New York estate, and it does not count toward the $7,350,000 exclusion or the $7,717,500 cliff.

The add-back does not reach annual exclusion gifts

New York’s three-year add-back (Tax Law § 954(a)(3)) applies to taxable gifts, meaning gifts above the annual exclusion that would be reported on a Form 709. Premium gifts covered by Crummey powers within $19,000 (or $38,000 split) per beneficiary are not taxable gifts and are never added back, no matter when the insured dies.

A transferred policy is the exception

A policy assigned to the trust within three years of death comes back under § 2035 federally and therefore for New York.

No New York GST tax

New York repealed its generation-skipping tax in 2014. Only the federal GST tax applies, so once GST exemption is allocated, a dynasty ILIT faces no state-level skip tax.

A worked example

A New York resident has a $5,500,000 estate: a house, investments and retirement accounts. She also owns a $2,500,000 policy on her own life, payable to her children.

The policy costs the family about $773,200 in New York tax purely because the insured owns it. The same policy in an ILIT costs nothing. If the trust bought the policy, the result holds whether she dies next year or in twenty; if she assigned an existing policy, the second column applies only if she survives three years. Premiums funded with $19,000 annual exclusion gifts per child are neither reportable nor added back.

Who an ILIT is for, and who it is not for

• Good fit: a New York resident whose assets plus insurance exceed, or will exceed, $7,350,000; an illiquid estate that will need cash for tax nine months after death; a married couple planning for the New York tax at the second death; families who want proceeds held in trust for young beneficiaries.
• Poor fit: an estate plus insurance comfortably below $7,350,000, someone who wants access to the policy’s cash value, or a family unwilling to keep up with annual notices and a separate trust account.

Pitfalls

• Paying premiums directly. It muddies the Crummey gift and suggests the insured still treats the policy as his own.
• Skipping the notices. No written Crummey notice, no present interest, no annual exclusion; every premium becomes a taxable gift and, in New York, a potential add-back.
• No hanging power. Beneficiaries make unintended gifts each year the lapse exceeds the 5-and-5 amount.
• Naming the estate as beneficiary or requiring the trust to pay estate debts. Both put the proceeds back under § 2042.
• Forgetting the GST allocation on a trust that will benefit grandchildren.

Related Estate Tax Planning Topics

• The New York Estate Tax Cliff – Why $7,717,500 pays about $735,000 and $7,350,000 pays nothing.
• SLAT – Often paired with an ILIT on the beneficiary spouse’s life.
• Form 709 – When premium gifts and GST allocations need a return.
• Portability – Federal only; why New York couples need the second death covered.
• Dynasty Trust – Holding insurance proceeds for grandchildren and beyond.

Talk to us about an ILIT

We draft ILITs with Crummey and hanging powers, coordinate the policy purchase or assignment, and prepare the Form 709 and GST allocation when a return is advisable. Call Albert Goodwin at 212-233-1233 or email [email protected] to find out whether your insurance is pushing your estate over the cliff.