A life insurance trust — commonly called an ILIT, short for irrevocable life insurance trust — is a legal arrangement in which a trust, rather than the insured person, owns one or more life insurance policies. When the insured passes away, the death benefit is paid to the trust and distributed to beneficiaries according to the trust’s terms. Because the insured person does not own the policy, the proceeds may be kept outside of that person’s taxable estate.
For many California families, a life insurance policy is one of the most significant assets they hold. Without careful planning, the proceeds from even a straightforward policy can increase the size of a taxable estate in ways that are easy to overlook. A life insurance trust is designed to address that problem by separating ownership of the policy from the person whose life it insures.
Why Life Insurance Can Create an Estate Tax Problem
Whether life insurance proceeds are included in a person’s taxable estate depends largely on who owns the policy and what control that person holds over it.
Under Internal Revenue Code Section 2042 — and the Treasury regulations issued under it at 26 CFR § 20.2042-1 — life insurance proceeds must be included in the gross estate of the insured in two situations. First, if the proceeds are payable to the insured’s estate. Second, and more commonly, if the insured held any “incidents of ownership” in the policy at the time of death.
Incidents of ownership include the right to change the policy’s beneficiary, to surrender or cancel the policy, to assign the policy, to borrow against it, or to receive its cash surrender value. These are rights most policyholders exercise without thinking of them in legal terms — but holding any one of them is enough under Section 2042 to include the entire death benefit in the taxable estate.
For 2026, the federal estate tax exemption is $15 million per individual, as published by the IRS following the enactment of the One Big Beautiful Bill, which permanently set a new higher base amount. For most California families, that threshold means the federal estate tax is not a present concern. But for families whose total assets — real estate, business interests, investments, and life insurance — may approach or exceed that figure, the proceeds of a large policy can become a meaningful part of the estate tax calculation. Amounts above the exemption are subject to federal estate tax at rates that can reach 40 percent.
An ILIT is one approach some families with larger estates use to keep life insurance proceeds from adding to that calculation. Whether it is the right approach depends on a family’s specific assets, goals, and overall plan — and is worth discussing with a California estate planning attorney.
Why Life Insurance Can Create an Estate Tax Problem
Whether life insurance proceeds are included in a person’s taxable estate depends largely on who owns the policy and what control that person holds over it.
Under Internal Revenue Code Section 2042 — and the Treasury regulations issued under it at 26 CFR § 20.2042-1 — life insurance proceeds must be included in the gross estate of the insured in two situations. First, if the proceeds are payable to the insured’s estate. Second, and more commonly, if the insured held any “incidents of ownership” in the policy at the time of death.
Incidents of ownership include the right to change the policy’s beneficiary, to surrender or cancel the policy, to assign the policy, to borrow against it, or to receive its cash surrender value. These are rights most policyholders exercise without thinking of them in legal terms — but holding any one of them is enough under Section 2042 to include the entire death benefit in the taxable estate.
For 2026, the federal estate tax exemption is $15 million per individual, as published by the IRS following the enactment of the One Big Beautiful Bill, which permanently set a new higher base amount. For most California families, that threshold means the federal estate tax is not a present concern. But for families whose total assets — real estate, business interests, investments, and life insurance — may approach or exceed that figure, the proceeds of a large policy can become a meaningful part of the estate tax calculation. Amounts above the exemption are subject to federal estate tax at rates that can reach 40 percent.
An ILIT is one approach some families with larger estates use to keep life insurance proceeds from adding to that calculation. Whether it is the right approach depends on a family’s specific assets, goals, and overall plan — and is worth discussing with a California estate planning attorney.
Crummey Powers and the Annual Gift Exclusion
Funding an ILIT involves a planning technique most people outside of estate planning have never heard of: Crummey powers.
The issue is this: gifts to a trust are not automatically treated as “present interest” gifts eligible for the annual federal gift tax exclusion. To use the exclusion — and avoid reducing the grantor’s lifetime exemption with every premium payment — the beneficiaries generally need to hold an immediate, real right to withdraw the contribution.
Crummey powers create that right. Each time the grantor makes a gift to the trust to cover a premium payment, the trustee sends written notices to the trust’s beneficiaries informing them that they have a window — typically 30 to 60 days — to withdraw their share of the contribution. In practice, beneficiaries almost never exercise this right, and the funds remain available for the trustee to pay premiums. But the existence of the withdrawal right is what allows the gift to qualify as a present-interest gift for tax purposes.
For 2026, the annual federal gift tax exclusion is $19,000 per recipient, as confirmed by the IRS. A grantor who makes contributions to an ILIT within that limit and sends timely Crummey notices may be able to fund premium payments without drawing on the lifetime exemption. Families with multiple trust beneficiaries may have additional capacity, depending on how the trust is structured.
Crummey notices need to be handled consistently and documented carefully each year. An estate planning attorney can help design the notice process and ensure it meets current requirements.
The Three-Year Lookback Rule
A common planning question is whether an existing life insurance policy can simply be transferred into an ILIT. The answer is yes — but there is an important timing risk to understand first.
Under Internal Revenue Code Section 2035, if an insured person transfers a life insurance policy to an irrevocable trust and then dies within three years of that transfer, the full death benefit is pulled back into the taxable estate. The IRS treats the transfer as if it never occurred for estate tax purposes. The three-year rule applies because the insured previously held incidents of ownership in the policy — even though those rights were surrendered when the trust was created.
The most straightforward way to avoid this risk is to have the ILIT apply for and purchase a brand-new policy from the outset, with the trust as the original and only owner. Because the insured never owned that policy, the three-year lookback has nothing to attach to.
When an existing policy is involved, the situation requires careful analysis. Gifting the policy to the trust starts the three-year clock. Other approaches, such as a sale of the policy to the trust, involve their own legal and tax considerations. A California estate planning attorney can help evaluate what makes sense given the specific policy, the family’s health and planning timeline, and the overall estate picture.
How a Life Insurance Trust Differs from a Revocable Living Trust
Many California families already have a revocable living trust as the foundation of their estate plan. A natural question is whether the revocable trust can simply hold the life insurance policy rather than setting up a separate ILIT.
The short answer is that a revocable living trust generally does not solve the estate tax problem that an ILIT is designed to address.
A revocable living trust can be changed, amended, or revoked by the grantor at any time. That flexibility is one of its most practical features — for avoiding probate, managing assets during incapacity, and organizing what passes to family after death. But because the grantor retains the ability to modify or revoke the trust, the grantor is also considered to retain incidents of ownership over any life insurance the trust holds. Under Section 2042, that means the proceeds would still be included in the taxable estate.
An ILIT is irrevocable. The grantor gives up those rights entirely — and that permanent loss of control is what may keep the insurance proceeds outside the estate for federal tax purposes. The two structures serve different purposes. A revocable trust addresses probate avoidance and asset management. An ILIT addresses a specific estate tax concern tied to life insurance. Some families use both as part of a coordinated plan.
For more on how these structures work in California, see our pages on the revocable living trust and how taxes work in a living trust.
Forming an ILIT Under California Law
California follows general trust law principles for the creation and administration of irrevocable trusts. A valid California trust requires a settlor with legal capacity, a designated trustee, an identifiable beneficiary, and trust property.
Because an ILIT is designed to achieve a specific federal tax result, the document must be drafted carefully. Trust provisions that inadvertently give the grantor retained rights — for example, certain trustee powers or beneficiary designation rights — could constitute incidents of ownership under Section 2042, potentially defeating the trust’s purpose.
The Crummey notice structure, the trustee succession provisions, and the distribution terms for the death benefit all need to be designed with these requirements in mind. Coordination with the life insurance carrier — to confirm the trust is properly named as owner and beneficiary — is also part of the setup process.
An estate planning attorney familiar with both California trust law and the federal tax rules governing life insurance can help ensure the document is structured correctly from the start.
Who May Consider a Life Insurance Trust
An ILIT is not a planning tool for every family. Because it is irrevocable and involves giving up meaningful control over a policy, the structure involves real tradeoffs. The potential tax benefit needs to be weighed against the loss of flexibility.
Some families who explore this structure include those with estates where a substantial life insurance policy could push the total value toward or past the federal exemption, business owners whose key-person or buy-sell coverage is part of a larger taxable estate, and parents who want life insurance proceeds to pass to children in a controlled, tax-efficient way.
An A/B trust and an ILIT can sometimes work alongside each other as part of a broader strategy for married couples with larger estates. California tax planning often involves coordinating several tools rather than relying on any single approach. A California estate planning attorney can help map out which structures make sense together.
How VK Law Can Help
VK Law works with California families on estate planning matters, including irrevocable trust design, trust formation, and the coordination of life insurance planning with broader estate goals. If you are weighing how a life insurance policy fits into your estate plan — or whether an ILIT may make sense given your family’s assets and goals — our attorneys can walk you through the considerations in plain language.
VK Law serves clients in California, Nevada, and New York and is available 24/7 by phone.
To talk with VK Law about your planning options, call 877-780-4727.
Frequently asked questions Life Insurance Trust
A life insurance trust — also called an ILIT — is an irrevocable trust that owns one or more life insurance policies. Because the insured person does not own the policy, the death benefit may be excluded from their taxable estate when they pass away. The trust receives the payout and distributes it to beneficiaries according to the trust document.
Incidents of ownership are rights that give the policyholder meaningful control over a life insurance policy. Under Internal Revenue Code Section 2042 and the Treasury regulations at 26 CFR § 20.2042-1, these include the right to change the beneficiary, surrender or cancel the policy, assign the policy, borrow against it, or receive its cash surrender value. Holding any one of these rights at the time of death may cause the full death benefit to be included in the taxable estate.
Generally, no — not if the goal is to keep the policy outside the taxable estate. Serving as trustee of an ILIT that holds a policy on your own life can cause the IRS to attribute the trustee's powers to you as incidents of ownership under Section 2042, which would pull the proceeds back into your estate. Most ILITs name an independent individual or a professional fiduciary as trustee.
The death benefit is paid to the ILIT. The trustee then distributes the proceeds to the trust's beneficiaries according to the trust document — either as an outright distribution, through a staged or structured payout, or as continuing management of funds in trust for a designated period.
Under Internal Revenue Code Section 2035, if a person transfers an existing life insurance policy to an irrevocable trust and dies within three years of that transfer, the full death benefit is generally included in the taxable estate. To avoid this risk, many families have the ILIT apply for and purchase a new policy rather than transferring an existing one.
California does not currently impose a separate state estate tax. The tax concern an ILIT is designed to address is the federal estate tax under the Internal Revenue Code. For California residents, the planning value of an ILIT is primarily at the federal level.
The grantor typically makes annual gifts to the trust, and the trustee uses those funds to pay the insurance premiums. To use the annual federal gift tax exclusion for these contributions, the trust should include Crummey provisions — written notifications to beneficiaries of their right to withdraw each contribution within a specified window. This process needs to be maintained consistently and documented each year.
