ILIT Returns
If your family has an irrevocable life insurance trust, the trust has its own tax return, even while the policy is still in force. We handle the filing and make sure Crummey letters are documented.
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What is an ILIT?
An irrevocable life insurance trust, usually called an ILIT, is a trust set up to own a life insurance policy. The reason is simple: if you own a life insurance policy when you die, the entire death benefit counts as part of your estate for estate tax purposes. For large estates, that can mean a significant tax bill on money that was supposed to go to your family.
By having a trust own the policy instead, the death benefit stays out of the estate. One important rule: if the insured transfers an existing policy into the ILIT and dies within three years, the death benefit is pulled back into the estate under the three-year lookback rule (IRC 2035(a)). Purchasing a new policy inside the trust avoids this risk entirely. The tradeoff is that “irrevocable” means the grantor gives up control. You can’t change the trust, take the policy back, or decide later that you want to cancel it. That loss of control is exactly what keeps the policy out of the estate; the IRS treats it as no longer yours because, legally, it isn’t.
How the trust is taxed
While the insured person is alive, the trust usually has very little income. Most ILITs hold just a checking or savings account used to pay the insurance premiums, and the only income is a small amount of interest on that account.
Many ILITs are treated as grantor trusts during the grantor’s lifetime. That means any income the trust earns is reported on the grantor’s personal return, not on a separate trust return, though a Form 1041 may still be filed as an informational return. This is a common and usually intentional setup: it lets the grantor pay the trust’s tax bill, which is effectively another tax-free gift to the trust.
After the insured dies and the trust receives the death benefit, things change. The trust starts earning real investment income, interest, dividends, capital gains on the proceeds, and that’s when the annual return becomes more involved. The trust may distribute income to beneficiaries (reported on Schedule K-1) or retain it and pay tax at trust rates.
Crummey letters
Every year, when the grantor puts money into the trust to pay the insurance premium, the trustee sends a letter to each beneficiary. The letter says you have the right to withdraw your share of the contribution within a set period, usually 30 days.
This isn’t a formality. It’s what makes the contribution qualify for the annual gift tax exclusion. Without the right to withdraw, the gift is a “future interest” gift that doesn’t qualify for the exclusion. If the letters aren’t sent and documented, the IRS can treat those contributions as taxable gifts that eat into the grantor’s lifetime exemption.
We track Crummey letter documentation as part of the annual filing. The letters need to be sent on time, to the right people, and kept on file. It’s the part of ILIT administration that can’t be skipped or backdated.
What the trustee needs to do
Administering an ILIT during the insured’s lifetime is not a heavy burden, but it does require attention to a few recurring tasks:
- Pay the insurance premiums on time
- Send and document Crummey letters for each contribution
- File Form 1041 annually
- Keep basic trust records: bank statements, premium notices, correspondence
Of these, the Crummey letters are the piece that matters most and the piece that’s easiest to let slip. Everything else is straightforward.
What we handle
- Annual Form 1041 for the ILIT
- Crummey letter tracking and documentation review
- Grantor trust reporting when applicable
- Schedule K-1 for beneficiaries (post-death distributions)
- Coordination with estate tax return (Form 706) at death
- Post-death trust administration returns
Frequently Asked Questions
Does an ILIT have to file a tax return?
Yes. An irrevocable life insurance trust is its own legal entity with its own EIN, and it files Form 1041 every year. While the insured person is alive, the return is often simple; the trust may have only a small amount of interest income from the account used to pay premiums. After the insured dies and the trust receives the death benefit, the returns become more substantive as the trust invests and distributes the proceeds.
What are Crummey letters and why do they matter?
Crummey letters are written notices the trustee sends to trust beneficiaries each time a contribution is made to the trust. The notice gives each beneficiary a temporary right to withdraw their share of the contribution, usually for 30 days. Nobody is expected to actually withdraw the money, but the right to withdraw is what makes the gift qualify for the annual gift tax exclusion. Without proper Crummey letters, the contributions could be treated as taxable gifts that use up the grantor’s lifetime exemption.
Can I be the trustee of my own ILIT?
Generally, no, or at least not without risk. If the grantor (the person whose life is insured) serves as trustee and retains any “incidents of ownership” over the policy, the death benefit could be pulled back into their taxable estate, defeating the purpose of the trust. Most ILITs name a family member, a trusted friend, or a professional trustee. Some estate planners allow the grantor’s spouse to serve as trustee, but this depends on how the trust is drafted and the state’s law.
What happens when the insured person dies?
The trustee files a claim with the insurance company, and the death benefit is paid to the trust, not to the estate. Because the trust owned the policy, the proceeds are not included in the deceased person’s taxable estate. The trust then holds or distributes the money according to its terms. From a tax perspective, the death benefit itself is not taxable income, but any investment income the trust earns after receiving it is taxable and reported on the trust’s annual return.