Estate Planning Guide
Irrevocable Life Insurance Trust (ILIT): How It Works, the 3-Year Rule, and When It Fits a Colorado Estate Plan
An irrevocable life insurance trust (ILIT) is a trust set up to own a life insurance policy on your life and to receive its proceeds. If it is structured correctly, the death benefit is generally kept out of your taxable estate. The trade-off is that once you sign it, you usually cannot change it, revoke it, or take the policy back.
This guide explains how an ILIT works under 2026 federal rules: Crummey notices, the three-year rule, what the trustee has to do, and when the structure may still fit a family's plan now that the exemption is higher. Think of it as a map you can use before you sit down with your estate attorney.
How It Works
How an ILIT Keeps Policy Proceeds Out of the Taxable Estate
Federal law counts life insurance proceeds in your gross estate if you held any "incidents of ownership" in the policy when you died. According to 26 U.S.C. § 2042 and Treasury Regulation § 20.2042-1, those incidents go beyond holding legal title. They include the power to change the beneficiary, surrender or cancel the policy, assign it, pledge it, or borrow against its cash value.
In an ILIT, the trust owns the policy and is named as its beneficiary, and an independent trustee manages it. You hold none of those powers, so the proceeds are generally not counted in your estate. After your death, the trustee pays out or holds the money under the terms you set. Results depend on how the trust is drafted and run. A mistake in either can bring the proceeds back into the estate.
The Three Parties in an ILIT
- 1 Grantor (you): creates and funds the trust, usually through yearly gifts that the trustee uses to pay premiums.
- 2 Trustee: owns the policy, pays the premiums, sends the required notices, and distributes the proceeds under the trust terms.
- 3 Beneficiaries: the spouse, children, grandchildren, or other people who receive benefits from the trust.
2026 Figures at a Glance
The Federal Numbers Behind ILIT Planning
$15M
Federal basic exclusion amount per person for 2026
$19,000
Annual gift exclusion per recipient for 2026
3 Years
Lookback period for transfers of existing policies
5%
Point above which a reversionary interest counts as an incident of ownership
Sources: IRS, What's New: Estate and Gift Tax (page reviewed July 23, 2026); IRS Rev. Proc. 2025-32, sections 4.14 and 4.42; 26 U.S.C. § 2035; 26 U.S.C. § 2042. As of October 19, 2026.
Side-by-Side Comparison
Owning a Policy Personally vs. Owning It Through an ILIT
Neither approach is right for every household. The table shows the general trade-offs. How they apply to you depends on your trust document, state law, and the policy you own.
| Feature | Owned Personally | Owned by an ILIT |
|---|---|---|
| Federal estate inclusion of death benefit | Generally included, because you hold incidents of ownership | Generally excluded if set up and run correctly, subject to the three-year rule |
| Control over beneficiaries | You can change them at any time | Set by the trust document; you generally cannot change them |
| Access to cash value | You can borrow or surrender, subject to policy terms | Controlled by the trustee; not available to you |
| How proceeds are distributed | Usually paid outright to named beneficiaries | Can be held, staggered, or kept in trust for long-term needs |
| Premium funding | Paid directly by you | You give money to the trust, often relying on the annual exclusion with Crummey notices |
| Administration | Minimal | Ongoing duties: notices, records, possible trust tax filings, and attorney fees |
| Flexibility | High | Limited; changes may need trust provisions or state-law steps your attorney arranges |
Funding the Trust
Crummey Notices and the 2026 Annual Gift Exclusion
Most ILITs are funded with yearly gifts that the trustee uses to pay premiums. The annual gift tax exclusion covers only gifts of a "present interest." A gift into a trust is usually a future interest, so it would not qualify on its own. A Crummey withdrawal right gives each beneficiary a short window to withdraw their share of the gift, and that is designed to turn the gift into a present interest.
According to IRS Rev. Proc. 2025-32, the 2026 annual exclusion is $19,000 per recipient. That means each Crummey beneficiary may support up to that amount of premium funding each year without using any of your lifetime exemption. Premiums above that amount generally use part of the exemption and may require a gift tax return. Your CPA or attorney can confirm the reporting.
You Make a Gift to the Trust
The money goes into the trust's account, not to the insurance company. Keeping that separation clean matters.
The Trustee Sends Crummey Notices
Each beneficiary is told in writing that they may withdraw their share within the period set in the trust document.
The Withdrawal Window Closes
If no one withdraws, the money stays in the trust. Beneficiaries cannot be required to decline, and any pre-arranged understanding may undermine the exclusion.
The Trustee Pays the Premium
The trustee pays the insurer from the trust account and keeps copies of the notices and payments.
Timing Matters
The 3-Year Rule for Transferring an Existing Policy
Under 26 U.S.C. § 2035, if you transfer an existing policy to an ILIT and die within three years of the transfer, the death benefit is generally counted back in your gross estate, as if you had never moved it. The statute also says the small-gift exception that applies to some other transfers does not apply to life insurance.
So the order of steps matters. When new coverage is needed, many estate attorneys have the trust created first and then have the trustee apply for and own the new policy from the start, which is designed to avoid the three-year lookback. Moving an existing policy can still make sense, for example when health changes make new coverage hard to get. The lookback risk should be weighed openly.
Questions to Raise Before a Transfer
- Is new coverage available, and on what underwriting terms?
- What is the policy's value for gift tax purposes, and how much exemption would the transfer use?
- Are there outstanding policy loans or other features that complicate the transfer?
- Has your attorney considered other transfer methods, and the tax rules that apply to them?
Ongoing Administration
Trustee Duties: What Keeps an ILIT on Course
Signing the trust document is only the start. An ILIT depends on steady administration year after year. The trustee may be a trusted person or a professional trustee, and the trust should spell out each responsibility clearly.
Send Notices on Time
Send Crummey notices after each gift and keep records that may be needed if the IRS questions an exclusion.
Pay Premiums From the Trust
Keep a separate trust account and avoid paying the insurer directly from your personal funds.
Monitor the Policy
Review policy statements and projections from time to time to check whether current funding still supports the coverage.
Handle Tax Filings
Work with a CPA to get a trust tax ID and file any required returns.
Act as a Fiduciary
Act for the beneficiaries' benefit, follow the trust terms, and avoid conflicts that state trust law prohibits.
Distribute Proceeds
After the insured's death, collect the death benefit and follow the trust's instructions for distributions, loans to the estate, or asset purchases.
The Trade-Off
Irrevocable Means Giving Up Control
The estate tax result of an ILIT depends on one thing: you give up control. That can be the right choice for some families. For others it is a real cost, and it should be weighed with care rather than glossed over.
Some trusts include flexibility features, such as a trust protector or limited powers to adjust administrative terms. State law may also allow certain changes through steps your attorney can explain. These features are not guaranteed to solve every future change in family or tax circumstances.
- 1You generally cannot change beneficiaries after a divorce, remarriage, or falling out with a family member.
- 2You give up personal access to any policy cash value.
- 3You take on setup costs, trustee costs, and yearly administrative work.
- 4If you stop funding premiums, the coverage may lapse or shrink, and the trust may end up with little to hold.
- 5Future tax law may change, and a trust built for one set of rules may fit later rules less well.
When It Fits
Where an ILIT May Fit a Colorado Estate Plan After P.L. 119-21
The IRS reports that Public Law 119-21 set the federal basic exclusion at $15 million for 2026 and made the higher amount a permanent part of the tax code, with inflation adjustments starting in 2027 (IRS, reviewed July 23, 2026). Colorado does not currently levy its own estate tax, according to the Colorado Legislative Council. For many households, then, an ILIT is now less about federal estate tax and more about control, liquidity, and family structure. Our 2026 estate tax exemption guide covers the threshold in more detail.
Larger Estates
Households whose combined assets, including life insurance, may exceed available exemptions could still face federal estate tax exposure.
Liquidity Needs
Business owners and families with real estate or closely held shares may want cash on hand so heirs are not pushed to sell assets. See our business succession planning guide. Owners may also need to coordinate ILIT-held policies with a buy-sell agreement.
Blended Families
An ILIT can set aside proceeds for children from a prior marriage while other assets go to a current spouse. Family dynamics still call for careful drafting.
Managed Distributions
Families who want proceeds paid out over time, or coordinated with a special needs trust, may value trust-level controls.
How Our Team Helps, and Where We Don't
Our insurance and planning team includes Melissa Lang (CLU®, ChSNC®, CLTC®), Tom Mueller (ChFC®), and Ryan Griffin (CFP®), Financial Planning Manager. We help families think through how much coverage may be appropriate, how premiums could be funded, and how an ILIT fits with investments, gifting, and life insurance planning. We do not draft trusts or give legal advice. We work alongside your estate attorney and CPA, who prepare the documents and advise on legal and tax matters. Insurance is offered through MML Investors Services, LLC (MassMutual), and our professionals may be paid when insurance is purchased. That is a conflict of interest, and we are glad to explain it, along with the alternatives we consider, before you decide anything.
Common Questions
Irrevocable Life Insurance Trust FAQs
Can You Put a Life Insurance Policy in an Irrevocable Trust?
Yes. You can transfer an existing policy to an ILIT, or the trustee can buy a new policy directly. A transferred policy is subject to the three-year rule under 26 U.S.C. § 2035. A policy bought directly by the trustee is generally designed to avoid that lookback.
Do I Need an ILIT if My Estate Is Below the $15 Million Exemption?
Not necessarily. With the 2026 federal exclusion at $15 million per person, many families may not need an ILIT for estate tax reasons. It may still be worth considering for liquidity, blended-family planning, or control over how proceeds are paid out. Our estate planning in Denver guide covers the wider picture.
What Should You Not Put in an Irrevocable Trust?
Assets you may need to reach or control later are often poor candidates, because an irrevocable transfer is generally permanent. Retirement accounts and some other assets have their own rules. Your estate attorney can explain which assets belong in which structure.
What Are the Alternatives to an Irrevocable Trust?
Alternatives include owning the policy personally with carefully chosen beneficiaries, having an adult child own the policy, or using a revocable trust for non-tax goals. Each has its own trade-offs in control, creditor exposure, and estate inclusion. Our Colorado will vs. trust comparison may help frame the choice.
Can I Be the Trustee of My Own ILIT?
Generally no. If you serve as trustee, you may be treated as holding incidents of ownership, which could bring the proceeds back into your estate. Families usually name a trusted person or a professional trustee.
How Does an ILIT Fit Into Multi-Generational Planning?
An ILIT can hold proceeds for children and grandchildren under terms you set, alongside gifting and other trusts, such as a spousal lifetime access trust or a grantor retained annuity trust. Generation-skipping transfer tax rules may apply, so careful coordination is needed. Learn more in our multi-generational wealth planning guide and our risk management and insurance planning overview.
Source notes, as of October 19, 2026: IRS, What's New: Estate and Gift Tax (reviewed July 23, 2026); IRS Rev. Proc. 2025-32; 26 U.S.C. § 2035; 26 U.S.C. § 2042; 26 C.F.R. § 20.2042-1; Colorado Legislative Council Staff, Estate Tax.
One Star to Guide the Way
See Where an ILIT Fits in Your Plan
An ILIT is one piece of a larger plan that includes your investments, insurance, gifting, and legacy goals. From our Denver office, The Stellarix Group works with families in all 50 states. We coordinate with your estate attorney and CPA so each part of your plan works together.
Schedule a Consultation(303) 692-8183 · 2000 S Colorado Blvd, Tower 2, Ste 800, Denver, CO 80222