The Instant Liquidity Engine: Irrevocable Life Insurance Trusts (ILIT)
The Instant Liquidity Engine: Irrevocable Life Insurance Trusts (ILIT)
Did you know your Life Insurance payout is subject to 40% Estate Tax? How to use an ILIT to uncouple the policy from your estate and create tax-free cash for your heirs.
Executive Summary
- The Hidden Trap: If you own a $10M life insurance policy on yourself, the IRS adds that $10M to your taxable estate at death. You thought you left your family $10M, but after the 40% tax, they only get $6M.
- The ILIT Solution: An Irrevocable Life Insurance Trust (ILIT) is a trust designed specifically to own the policy. Since you don’t own it (the Trust does), the death benefit is 100% excluded from your estate.
- Liquidity Function: Rich families often have “asset rich, cash poor” estates (Real Estate, Businesses). When the 40% estate tax bill comes due (within 9 months), the ILIT provides the instant cash to pay the IRS, preventing the forced sale of the family business.
The 3-Year Lookback Rule
Critical Warning: If you transfer an existing policy into an ILIT and die within 3 years, the IRS pulls it back into your estate (Taxable).
👉 Best Practice: Don’t transfer old policies. Have the ILIT apply for and purchase a NEW policy from day one. This bypasses the 3-year rule completely.
Mechanic: The “Crummey” Process
0% Tax
Estate Excluded
Crummey Letter
Gift Qualification
Liquidity
Pay IRS in Cash
Irrevocable
No Taking Back
Simulation: Personal Ownership vs. ILIT ($10M Death Benefit)
Net Benefit to Heirs
| Feature | Personal Ownership | ILIT Ownership |
|---|---|---|
| Owner | You (The Insured) | The Trustee |
| Estate Tax | Included (Taxable) | Excluded (Tax-Free) |
| Creditor Protection | Low (Cash value seizable) | High (Trust assets protected) |
“Life insurance is intended to solve problems, not create tax liabilities. An ILIT ensures that the life raft doesn’t sink the ship by adding weight to your taxable estate.”
Essential Resources
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