Life insurance is one of the most effective ways to provide financial security for your family. What surprises many New York residents is that the proceeds, while generally income-tax-free to the beneficiaries, are fully includable in your taxable estate for both federal and New York State estate tax purposes. For a family with substantial assets, that inclusion can produce a significant estate tax bill and shrink the legacy that reaches the heirs. An Irrevocable Life Insurance Trust (ILIT) removes the proceeds from your taxable estate while making sure the beneficiaries get the full benefit.
We design, draft and administer ILITs for clients throughout New York that comply with federal tax law and New York law. If you want to reduce estate tax exposure, provide liquidity for estate settlement costs, protect assets for future generations, or make sure the proceeds are managed responsibly for your beneficiaries, an ILIT may belong in your estate plan.
What Is an Irrevocable Life Insurance Trust?
An ILIT is a trust created specifically to own a life insurance policy on the life of the grantor, the person who creates the trust. Once the trust is established and the policy is transferred to it or bought by it, the grantor gives up ownership and control of the policy. Because the trust, not the insured, owns the policy, the death benefit is excluded from the insured’s gross estate for estate tax purposes, provided the trust is properly structured and administered.
The trust agreement tells the trustee how to manage the policy during the grantor’s lifetime and how to distribute the proceeds after death. The trust is irrevocable: its terms generally cannot be amended or revoked once it is established. That permanence is what gives the ILIT its tax-saving power, and it is why the drafting has to be right at the outset.
Why ILITs Matter for New York Residents
New York imposes its own estate tax separate from the federal estate tax. For deaths in 2026, New York’s basic exclusion amount is $7.35 million, adjusted annually. New York also has a “cliff”: if the taxable estate exceeds 105% of the exclusion amount, the entire estate becomes subject to New York estate tax, not just the amount above the threshold. An estate that falls just above the exclusion can face a dramatically higher tax bill.
Life insurance can easily push an estate over that line. Consider a New York resident with a $5 million estate and a $3 million life insurance policy. Without planning, the combined $8 million estate exceeds the New York exclusion and triggers substantial estate tax. By moving the policy into a properly structured ILIT, the $3 million in proceeds is excluded from the New York taxable estate, potentially saving hundreds of thousands of dollars.
The federal estate tax also applies to larger estates, with a $15 million per-person exemption for 2026 that the One Big Beautiful Bill Act of July 2025 made permanent and indexed for inflation. Because life insurance proceeds are added to the taxable estate, a large policy can push a New York family over the state cliff even when no federal tax is due. An ILIT protects against both layers of tax.
What an ILIT Does for You
The primary benefit is estate tax reduction: the proceeds are removed from the insured’s gross estate, which for a family with significant wealth preserves substantial assets for the next generation. The second is liquidity. Many estates consist of real estate, business interests or investment holdings that are hard to turn into cash quickly. An ILIT gives the trustee a source of liquid funds that can be used, through loans to the estate or purchases of estate assets, to help pay taxes, debts and administration expenses without a forced sale of family assets.
Assets in a properly drafted ILIT are also generally shielded from the creditors of both the grantor and the beneficiaries, which matters for a beneficiary who may face divorce, a lawsuit or financial difficulty. The grantor controls how and when the beneficiaries receive distributions: instead of a lump sum to a young or financially inexperienced beneficiary, the trust can provide staggered distributions, distributions for specific purposes such as education or health care, or lifetime trusts for multiple generations. And the ILIT can be structured to use the generation-skipping transfer (GST) tax exemption, so that wealth passes to grandchildren and more remote descendants without an additional transfer tax at each generation.
How an ILIT Works
Establishing and operating an ILIT involves four stages and some ongoing administration.
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Creating the trust
We draft a trust agreement built around the grantor’s objectives. The grantor selects a trustee, who must be someone other than the grantor to preserve the tax benefits: often a trusted family member, a professional fiduciary or a corporate trustee.
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Funding the trust
The ILIT acquires the policy in one of two ways: by purchasing a new policy directly, or by receiving an existing policy from the grantor by assignment. If an existing policy is transferred, the three-year rule of Internal Revenue Code Section 2035 applies: if the insured dies within three years of the transfer, the proceeds are pulled back into the estate. For that reason, having the trust buy a new policy from the outset is often preferable.
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Premium payments and Crummey notices
The grantor typically funds the trust each year with cash gifts equal to the premium. To qualify those gifts for the annual gift tax exclusion (currently $19,000 per recipient in 2026), the trust must contain “Crummey” provisions, named after Crummey v. Commissioner, which give the beneficiaries a temporary right to withdraw each contribution. The trustee must send written Crummey notices to the beneficiaries each time a contribution is made. The beneficiaries usually let the right lapse, but the formal notice is essential for tax compliance.
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Trust administration
The trustee pays the premiums, keeps the trust records, files any required tax returns and administers the policy under the trust terms. When the insured dies, the trustee collects the death benefit and distributes it in accordance with the trust agreement.
Common Pitfalls in ILIT Planning
An ILIT works only if it is properly drafted and administered. These are the mistakes that most often undo the tax benefits.
| Mistake | Consequence |
|---|---|
| Retaining incidents of ownership, such as the right to change beneficiaries, borrow against the cash value or surrender the policy | The proceeds are includable in the grantor’s estate |
| Failing to send Crummey notices | Contributions may not qualify for the annual exclusion, producing unintended gift tax consequences |
| Naming the grantor as trustee | The trust assets can be includable in the grantor’s estate |
| Improper transfer of an existing policy, or paying premiums directly to the insurer rather than through the trust | The three-year rule or the trust structure is compromised |
| Inadequate trust funding | The policy can lapse, defeating the purpose of the trust |
| Failing to update the policy’s beneficiary designation and ownership | The trust must be the named beneficiary and the trustee must be the policy owner; otherwise the proceeds are not sheltered |
Who Should Consider an ILIT?
An ILIT is not for every situation. It is most useful for individuals or couples whose combined estates approach or exceed the New York or federal exclusion; business owners who need liquidity for succession planning or a buy-sell arrangement; owners of illiquid assets such as real estate, a family business or an art collection; parents or grandparents who want to provide structured benefits to younger or financially inexperienced beneficiaries; people concerned about asset protection for themselves or their beneficiaries; families carrying out multi-generational wealth transfer; and spouses planning around a second marriage or a blended family.
For a smaller estate that falls well below the exclusion thresholds, the cost and administrative burden of an ILIT may outweigh the benefit. The decision turns on a careful analysis of your assets and goals.
Choosing the Right Trustee
The trustee will manage the policy, send the Crummey notices, pay the premiums and ultimately distribute the proceeds, so the choice matters. The grantor cannot serve as trustee. A spouse sometimes can, but that creates complications, particularly if the spouse is also a beneficiary. The trustee must be reliable enough to perform the administrative tasks year after year, often for decades, and financially sophisticated enough to understand the policy and the trust’s investment and distribution responsibilities. Because ILITs last so long, naming a corporate trustee or providing for successor trustees is often advisable.
Coordinating an ILIT With Your Overall Estate Plan
An ILIT does not operate in isolation. It has to be coordinated with your will, revocable living trust, business succession plan, retirement account beneficiary designations and other instruments. The questions to settle are how the ILIT interacts with marital deduction planning and credit shelter trusts; whether the ILIT will buy assets from the estate or lend it funds to provide liquidity; how the trust beneficiaries line up with the beneficiaries of the other estate planning vehicles; whether the trust should be designed as a generation-skipping trust to use the GST exemption; and how the ILIT fits with any charitable giving. A properly integrated plan has all of these parts working together while minimizing taxes and administrative complications.
Tax Considerations and Reporting
Although the main purpose of the ILIT is to reduce estate tax, other tax rules apply throughout its life. A gift tax return (Form 709) may be required when contributions are made, particularly if they exceed the annual exclusion or the Crummey procedures were not followed. GST allocations have to be managed carefully to make the most of the GST exemption. The trust itself may have income tax filing obligations depending on the policy and any investment income it generates. We work with your tax professionals to keep the trust in full compliance.
How We Help With an ILIT
Our work on an ILIT covers the full cycle: evaluating whether an ILIT suits your situation and goals; drafting the trust agreement; coordinating with insurance professionals to structure or transfer the policy; advising the trustee on administrative duties, including the Crummey notice procedure; preparing the required gift tax returns and GST allocations; reviewing and updating an existing ILIT to keep it compliant with changing law; integrating the ILIT with the broader estate plan; and counseling beneficiaries on their rights and responsibilities under the trust.
Talk to Us About an ILIT
The technical requirements and the irrevocable nature of these trusts mean that mistakes at the drafting or administration stage can be lasting and costly. Whether you are deciding whether an ILIT belongs in your plan, serving as the trustee of one, or a beneficiary who wants to understand how it works, call us at 212-233-1233 or email [email protected].
