ILIT Administration: A Trustee's Guide to Irrevocable Life Insurance Trusts

An irrevocable life insurance trust (ILIT) is a special-purpose trust that owns a life insurance policy on the grantor's life. As ILIT trustee, your ongoing duties are mostly quiet — collecting premiums, sending annual Crummey notices, keeping records — until the insured dies. Then the trust receives a large, income-tax-free payout and you become responsible for distributing it correctly. Here's what every ILIT trustee needs to know.

Why ILITs exist

Life insurance proceeds paid to an individual's own estate — or to a policy the insured personally owned — are included in the taxable estate under IRC § 2042. For estates large enough to face federal estate tax, that could mean 40% of the policy payout going to the IRS rather than to heirs.

An ILIT solves this by having the trust own the policy from inception. Because the insured has no "incidents of ownership" over the policy, the death benefit is excluded from the insured's taxable estate under § 2042.¹ The trust receives the proceeds income-tax-free under IRC § 101(a), and distributes them to beneficiaries according to its terms — estate-tax-free.

The ILIT typically works like this:

• The grantor creates the ILIT and names an independent trustee (often a trusted adult child or professional trustee — not the grantor).
• The trustee applies for and owns the life insurance policy on the grantor's life.
• Each year, the grantor makes a gift to the ILIT. The trustee notifies beneficiaries of their withdrawal rights (Crummey notices), then pays the premium from the trust's funds.
• At the grantor's death, the insurer pays the death benefit directly to the trust. The trustee holds and distributes the proceeds according to the trust document.

The three-year rule: why the grantor cannot simply transfer an existing policy

A grantor cannot avoid estate inclusion by transferring an existing, personally-owned policy to an ILIT shortly before death. Under IRC § 2035, if the grantor transfers any life insurance policy to an irrevocable trust within three years of death, the full death benefit is pulled back into the taxable estate.² This is why estate attorneys typically establish ILITs with new policies — having the trust apply for and own the policy from inception avoids the three-year trap entirely.

If you are administering an ILIT that received a transferred (not newly-issued) policy, confirm with the estate attorney whether the grantor survived the three-year window. If not, the death benefit may be estate-taxable despite the ILIT structure.

Your annual duty: Crummey notices

Every time the grantor gifts money to the ILIT — typically once a year to fund the premium — you must send a written Crummey notice to each beneficiary.³ This step is not optional and cannot be ratified after the fact.

Why this is required

The annual gift tax exclusion ($19,000 per recipient in 2026) only applies to gifts of a "present interest" — meaning the recipient can use the money right now.⁴ A gift to an irrevocable trust is normally a future interest (the beneficiary can't touch it until the trust terms allow), which would not qualify for the annual exclusion and would count against the grantor's lifetime exemption instead.

The Crummey v. Commissioner solution: give each beneficiary a temporary right to withdraw their proportionate share of the gift — typically for 30 days. That right makes the gift a present interest, qualifying it for the annual exclusion. The beneficiary almost never exercises the withdrawal right in practice (doing so would shrink the trust and irritate everyone), but the legal right must be real, documented, and communicated.

What a Crummey notice must contain

• Date of the gift to the trust
• Amount of the gift (and each beneficiary's pro-rata share if different)
• The beneficiary's withdrawal right and the specific dollar amount they may withdraw
• The deadline for exercising the right (typically 30 days from notice date)
• Where to contact the trustee to exercise the right

Send the notice to each beneficiary by certified mail or another method that creates a paper trail. Keep a copy of each notice and the mailing confirmation in the trust's permanent records.

Audit exposure

IRS audit of a Form 709 (gift tax return) that claimed annual exclusions for ILIT premium gifts frequently focuses on Crummey notice documentation. If you cannot produce notices for every gift year, the IRS can reclassify those gifts as future-interest gifts — disqualifying the annual exclusion and potentially triggering gift tax liability for the grantor's estate. Retroactive reconstruction of notices does not cure the problem.

Premium oversight: keeping the policy in force

As trustee, you are responsible for ensuring the insurance policy does not lapse. A lapsed policy is a total loss of the trust's only asset — and the grantor's death after lapse produces no death benefit. Trustees have been held personally liable for policy lapses when they failed to take reasonable steps to prevent them.

Your practical duties around the policy:

• Know the premium due dates. Set calendar reminders well ahead of each due date. Confirm the grantor has made (or plans to make) the annual gift to fund the premium payment.
• Verify the policy annually. Request an in-force illustration from the insurer once a year. For universal life and variable life policies, low cash value or poor policy performance can accelerate lapse; term policies are simpler but still require timely payment.
• Communicate early if the grantor cannot fund the gift. If the grantor's circumstances change and they cannot fund the premium, the trustee must act. Options include using accumulated trust cash value (if any), reducing the death benefit to lower the premium, or coordinating with the estate attorney on whether the policy can be sold (via a life settlement) or surrendered if it no longer serves a purpose.
• Never pay the premium directly from your personal funds on the expectation of reimbursement. That creates an undocumented loan to the trust, complicates the Crummey analysis, and puts your own tax situation at risk.

When the insured dies: the death claim process

The ILIT becomes active immediately at the insured's death. The death benefit — which can range from hundreds of thousands to tens of millions of dollars — flows into the trust, and you are now responsible for managing and distributing it.

Step 1: File the death claim

Contact the insurance company promptly after the insured's death. You will need:

• Original death certificate (typically 3–5 certified copies)
• The original policy, if available (or a lost-policy affidavit)
• A certified copy of the ILIT trust document
• Your trustee certification or Certificate of Trust evidencing your authority

Large carriers typically pay within 30–60 days of receiving complete documentation. Interest accrues on the death benefit during the claim period at rates set by state law.

Step 2: Open a trust account for the proceeds

The proceeds must go into a trust account — not your personal account, not the beneficiaries' accounts. The trust needs its own EIN if it does not already have one (file IRS Form SS-4). Deposit the death benefit into a federally insured account titled in the trust's name.

Step 3: Income tax status of the proceeds

Life insurance death benefits are income-tax-free to the recipient under IRC § 101(a).⁵ The trust receives the full death benefit without any federal income tax. This is one of the most significant tax advantages of life insurance in general — and it applies whether the beneficiary is an individual or a trust.

Caveat: interest that accrues between the date of death and the payment date is taxable income to the trust. If the carrier takes 45 days to pay and accrues $12,000 in interest, that interest is reportable on Form 1041.

Step 4: Hold and distribute according to the trust terms

Once the trust holds the proceeds, your distribution duties kick in. Read the trust document carefully — ILIT distribution terms vary significantly:

• Outright distribution: Some ILITs simply require distributing the proceeds to named beneficiaries after the insured's death. Relatively simple to administer — prepare a final accounting, make the distributions, collect receipts and releases, and close the trust.
• Held in continuing trust: Many ILITs continue as an ongoing trust after the death, with the trustee managing the proceeds over time — typically for minor children, disabled beneficiaries, or spendthrift situations. Now you have an ongoing investment management duty under the Uniform Prudent Investor Act.
• HEMS distributions from the continuing trust: If the trust holds proceeds for adult beneficiaries under a HEMS standard, you apply the same analysis as any other discretionary trust. See our distribution decisions guide.

ILIT income tax and Form 1041

During the policy-in-force period, ILITs typically have minimal taxable income — perhaps interest on small cash balances, or dividends if the trust holds any investment account. Most of the action is the premium payments (not taxable) and the Crummey gifts (not income to the trust).

After the insured's death, if the trust continues and holds the death benefit proceeds in an investment account, it will generate investment income — interest, dividends, capital gains. That income is subject to the compressed trust income tax rates:

• Ordinary income: 37% on retained income above $16,000 in 2026 (compared to $640,000+ for a single individual)⁶
• Long-term capital gains: 20% + 3.8% NIIT = 23.8% on gains above approximately $16,250

The same distribute-vs-retain analysis that applies to any irrevocable trust applies here: if beneficiaries are in lower brackets than 37%, distributing investment income to them saves the family significant tax. The trust deducts distributions (the distribution deduction under DNI rules), and beneficiaries report the income on their own returns via Schedule K-1.

File Form 1041 for each year the ILIT has any taxable income. A CPA with trust tax experience should prepare the return — the first year after the insured's death requires careful attention to the partial-year income allocation and the treatment of any interest that accrued during the death claim period. See our Form 1041 trustee guide.

Does your ILIT still make sense post-OBBBA?

The One Big Beautiful Bill Act (July 2025) permanently raised the federal estate and gift tax exemption to $15 million per individual ($30 million for a married couple) starting in 2026, indexed for inflation going forward.⁷ This is a dramatic change from the pre-OBBBA environment, where the exemption was scheduled to drop back to roughly $7 million per person in 2026.

For most families — those with combined estates under $30 million — the ILIT's primary estate tax purpose is now largely moot. The life insurance proceeds would have passed estate-tax-free anyway, with or without the trust structure.

However, the ILIT itself is irrevocable and cannot simply be undone by trustee action alone. The policy is still in force. Your options depend on the trust document and state law:

• Continue as-is: The trust still provides real non-tax benefits — spendthrift protection (creditors of beneficiaries cannot reach trust assets), professional management of the payout, and controlled distribution timing. For families with beneficiaries who have creditor issues or spending concerns, continuing the trust remains sensible even without the estate tax motivation.
• Sell or surrender the policy: If the ILIT's estate tax purpose is fully gone and the trust provides no meaningful non-tax benefit, the trustee (with appropriate authorization from beneficiaries or a court) may be able to sell the policy via a life settlement or surrender it for cash value. Consult the trust document and an estate attorney before taking this step.
• Modify or terminate the trust: Under UTC § 411, all qualified beneficiaries may consent to termination if it is not inconsistent with a material purpose of the trust. If the original purpose was purely estate tax savings, and that purpose is now moot, consent termination may be appropriate. Court approval is an alternative if consent is impractical (minor beneficiaries, unborn remaindermen).

None of these decisions should be made without legal counsel. The trust document may have specific termination or modification provisions that differ from default UTC rules.

Common ILIT trustee mistakes

• Skipping Crummey notices. The most common and most costly error. No notice = no annual exclusion = potential gift tax liability for the grantor's estate.
• Not keeping notice records. Even if notices were sent, the inability to produce documentation during an audit produces the same problem as not sending them.
• Letting the policy lapse. Once the policy lapses, it is often unrecoverable. Trustees have personal liability for this outcome when due care could have prevented it.
• Allowing the grantor to control the policy. If the grantor retains incidents of ownership — even something as seemingly minor as having the right to change the beneficiary designation or borrow against the policy — the death benefit gets pulled back into the taxable estate under IRC § 2042.
• Failing to open a separate trust account for proceeds. At the insured's death, proceeds must go into a trust account — not a personal account, not commingled with any other assets.
• Missing Form 1041 after proceeds are invested. Once the trust holds an investment portfolio generating income, it must file annually — even small trusts.
• Ignoring the OBBBA context without legal review. Trustees who continue complex, costly ILIT administration for estates that no longer need the structure may be acting against the beneficiaries' interests. Get an opinion.