Irrevocable Life Insurance Trust (ILIT): Arizona Guide

You signed the papers. Your Irrevocable Life Insurance Trust (ILIT) now exists, and its job is simple to state: when you die, the life insurance death benefit lands in the trust instead of in your taxable estate, so the federal government does not take 40% of it. But signing the trust is the beginning, not the end. An ILIT only works if you, the grantor, and the person you chose as trustee follow a strict set of federal tax rules for as long as the policy is in force. Break the rules and the IRS can pull the entire death benefit back into your estate, which defeats the reason you created the trust.

 

An Irrevocable Life Insurance Trust is a trust you create while you are alive for one main purpose: to own life insurance on your life and receive the death benefit when you die. You choose a trustee to manage the trust, and you name the beneficiaries, usually your spouse, children and grandchildren. The trustee, not you, applies for and owns the policy, and the trustee is named as the policy's beneficiary. Because the trust is irrevocable, you give up the right to cancel it, change it or control the policy. That surrender of control is what makes the ILIT work.

 

Why would someone adopt an ILIT? Because life insurance you own personally is included in your taxable estate. A person with a $14 million net worth who owns a $5 million policy has a $19 million taxable estate, and the $4 million above the 2026 federal exemption of $15 million could cost the family $1.6 million in federal estate tax. If an ILIT owns the same policy, the $5 million death benefit is not part of the estate, the taxable estate stays under the exemption, and the family receives the full $5 million free of federal estate tax and income tax.

 

An ILIT offers other benefits too. It can provide cash to pay estate taxes and expenses so your family does not have to sell a business, real estate or other assets in a hurry. The death benefit is paid to the trustee outside of probate. The trust can protect the money from your beneficiaries' creditors, lawsuits and divorces, and from young or financially inexperienced beneficiaries who might spend it too quickly. And the trust can give the money to your spouse during his or her lifetime and then to your children, without the proceeds being taxed again in your spouse's estate.

 

This article explains in plain English everything you need to know as the grantor, and everything your trustee needs to know to manage the trust in compliance with the Internal Revenue Code. Give a copy to your trustee.

What's in This Article

• How an ILIT Keeps Life Insurance Out of Your Taxable Estate
• Part 1: What You Must Know as the Grantor
• Part 2: What the Trustee Must Know to Comply With Federal Tax Law
• The ILIT Annual Compliance Calendar
• What the Trustee Does When the Grantor Dies
• The 15 Mistakes That Can Destroy an ILIT
• ILIT Frequently Asked Questions

How an ILIT Keeps Life Insurance Out of Your Taxable Estate

Most people are surprised to learn that life insurance is not automatically "tax free." The death benefit is free of federal income tax to the person who receives it under IRC §101(a). But the death benefit is subject to federal estate tax if you own the policy when you die.

 

Under IRC §2042, the death benefit of a policy on your life is included in your gross estate if (1) the proceeds are payable to your estate or your executor, or (2) you possessed any "incident of ownership" in the policy at your death. A $5 million policy you own personally adds $5 million to your taxable estate. If your estate is already above the exemption, that policy could generate $2 million of federal estate tax.

 

An ILIT solves the problem by making the trust, not you, the owner and the beneficiary of the policy. Because you have no incidents of ownership and the proceeds are not payable to your estate, the death benefit is not part of your estate. The trustee collects the money and holds or distributes it to your spouse, children or other beneficiaries according to the terms of the trust you signed.

 

The three parties to every ILIT are:

• The grantor (also called the settlor or trustor). That is you, the person who created the trust and whose life is insured.
• The trustee. The person or company that owns the policy, manages the trust, pays the premiums and follows the tax rules. The trustee should not be you.
• The beneficiaries. The people who will benefit from the trust, usually your spouse and children, and who hold the "Crummey" withdrawal rights described below.

Part 1: What You Must Know as the Grantor

1. Your ILIT Cannot Be Revoked or Changed by You

"Irrevocable" means what it says. You cannot cancel the trust, take the policy back, change the beneficiaries or rewrite the terms. That loss of control is exactly what keeps the insurance out of your estate. If you kept the power to change the trust, IRC §2036 and IRC §2038 would pull the trust assets back into your estate.

 

That does not mean an ILIT is frozen forever. Arizona law gives some flexibility that does not require you to hold any power. A trustee may in some circumstances "decant" the trust (pour the assets into a new trust with updated terms) under A.R.S. §14-10819, and the trustee and beneficiaries can sometimes fix problems with a nonjudicial settlement agreement under A.R.S. §14-10111. Any change must be reviewed by an attorney first so it does not create an incident of ownership or a taxable gift.

2. You Must Never Hold Any "Incident of Ownership" in the Policy

This is the most important rule in the entire ILIT world. Treasury Regulation §20.2042-1(c)(2) says an incident of ownership is broader than legal title. It includes the power to change the beneficiary, to surrender or cancel the policy, to assign the policy, to revoke an assignment, to pledge the policy for a loan, or to borrow against the cash value. If you hold any one of those powers when you die, in any capacity, the entire death benefit is in your estate.

 

As the grantor you must never:

• Serve as trustee or co-trustee of your own ILIT.
• Sign a beneficiary change form, a policy loan request, a surrender request or any other policy document as the "owner." Only the trustee signs.
• Borrow against the cash value of the policy or use the policy as collateral for your own loan.
• Hold a power to remove the trustee and appoint yourself, or to appoint someone who is "related or subordinate" to you under IRC §672(c) (for example, your employee or a sibling who works for you). The IRS allows a grantor to hold a power to replace the trustee with an independent trustee who is not related or subordinate to the grantor (Revenue Ruling 95-58).
• Name your estate, your executor or your revocable living trust as the beneficiary of the policy. The beneficiary must be the ILIT trustee.

3. The Three-Year Rule if You Transferred an Existing Policy

If the ILIT applied for and bought a brand-new policy on your life, the three-year rule does not apply and the death benefit is out of your estate from day one.

 

If instead you gave a policy you already owned to the ILIT, IRC §2035(a) says the entire death benefit is pulled back into your estate if you die within three years after the transfer. There is nothing a trustee can do to avoid this rule. That is why we prefer to have the trustee apply for a new policy whenever your health makes that possible. If an existing policy was transferred, mark the three-year anniversary on your calendar.

 

A transfer of an existing policy also raises gift tax and income tax issues. The value of the policy you gave (generally its interpolated terminal reserve or replacement value, which the insurance company reports on IRS Form 712) is a gift that may require a gift tax return. A transfer of a policy can also trigger the "transfer for value" rule of IRC §101(a)(2), which can make part of the death benefit taxable income. A gift for no consideration and a transfer to a trust that is a "grantor trust" as to the insured generally avoid that rule (Revenue Ruling 2007-13), but this must be confirmed before the transfer.

4. How You Pay the Premiums: Gifts to the Trustee

The trust owns the policy, so the trust must pay the premiums. Most ILITs have no money of their own, so you pay for the insurance by making cash gifts to the trustee. The trustee deposits your gift into the trust bank account, sends the required Crummey notices, and then writes the premium check from the trust account.

 

Follow these rules every time:

• Write the check to the trustee of the ILIT, payable to the trust and deposited in the trust's bank account. Do not pay the insurance company directly, and do not have the premium automatically drafted from your personal account.
• Make the gift early. Give the trustee your gift at least 30 to 45 days before the premium due date so the beneficiaries' withdrawal period can expire before the premium is paid.
• Tell the trustee in writing that the money is a gift to the trust. A short cover letter is fine and becomes part of the trust's records.
• Never take money back from the trust and never use trust funds for your own expenses.

Paying the insurer directly is not instantly fatal, because the IRS treats a premium you pay directly as an indirect gift to the trust. But it short-circuits the Crummey notice process, it can disqualify the gift for the annual exclusion, and it makes the trust's records look like you are still treating the policy as yours. Don't do it.

5. Crummey Powers: How Your Premium Gifts Qualify for the $19,000 Annual Exclusion

Under IRC §2503(b), the $19,000 annual gift tax exclusion only applies to gifts of a "present interest," meaning the recipient can use the gift now. A gift to an ILIT is normally a gift of a future interest because the beneficiaries get nothing until you die. Without help, every dollar you give the ILIT would use up part of your $15 million lifetime exemption and require a gift tax return.

 

The fix is the Crummey power, named after Crummey v. Commissioner, 397 F.2d 82 (9th Cir. 1968), a federal appeals court decision from the circuit that includes Arizona. Your ILIT gives each beneficiary a temporary right to withdraw his or her share of each gift you make to the trust. Because each beneficiary could take the money now, the gift is treated as a present interest and qualifies for the annual exclusion. In Estate of Cristofani v. Commissioner, 97 T.C. 74 (1991), the Tax Court allowed the exclusion even for contingent beneficiaries such as grandchildren who held real withdrawal rights.

 

Here is the math. If your ILIT gives Crummey withdrawal rights to your three children, you can give the trust up to $57,000 in 2026 (3 x $19,000) with no gift tax and no use of your lifetime exemption. If you are married and your spouse consents to split gifts, the amount doubles to $114,000. Remember that the $19,000 per recipient is a single annual limit. Gifts you make directly to the same child during the same year (birthday checks, tuition paid to the child rather than directly to the school, holiday gifts) use up part of that child's $19,000.

 

The Crummey power only works if it is real. That means:

• The trustee must actually notify each beneficiary in writing each time you make a gift.
• Each beneficiary must have a reasonable period, usually at least 30 days, to exercise the withdrawal right.
• There must be no agreement, express or implied, that the beneficiaries will not withdraw. You can explain the purpose of the trust to your family, but you cannot threaten to disinherit anyone who exercises a withdrawal right. The IRS attacks Crummey powers when it finds a prearranged understanding.
• The trust must have the money available during the withdrawal period. If a beneficiary asks for his share, the trustee must pay it.

6. The "5 and 5" Lapse Rule

When a beneficiary lets a withdrawal right expire, the law treats the lapse as a release of a general power of appointment. Under IRC §2514(e) and IRC §2041(b)(2), a lapse is ignored only to the extent it does not exceed the greater of $5,000 or 5% of the trust assets. If a beneficiary's withdrawal right is $19,000 and it lapses, the excess above $5,000 (or 5%) is treated as a gift by the beneficiary to the other trust beneficiaries.

 

Many ILITs handle this with a "hanging power," which lets the portion of the withdrawal right above the 5-and-5 limit carry over to future years instead of lapsing all at once. Others limit each withdrawal right to $5,000 per year. Ask your attorney which approach your trust uses, because it affects how much you should give each year and what the trustee's notices must say.

7. When You Must File a Federal Gift Tax Return (Form 709)

Under IRC §6019 you must file IRS Form 709 for any year in which you:

• Give the ILIT more than the total annual exclusions available to the Crummey beneficiaries.
• Give the ILIT a gift that does not qualify for the annual exclusion (for example, because the trust lacks Crummey powers or the trustee failed to give notice).
• Elect to split gifts with your spouse under IRC §2513. Gift splitting always requires a return, and it is generally not available for gifts to a trust in which your spouse is a beneficiary unless your spouse's interest can be separately valued.
• Transfer an existing policy to the ILIT, if its value exceeds the available exclusions.
• Need to allocate generation-skipping transfer tax exemption to the trust (see below).

Form 709 is due April 15 of the year after the gift. An extension of your income tax return also extends the gift tax return. The penalties for failing to file are real, and if no return is filed, the IRS statute of limitations to challenge the value of the gift never starts running. Even when a return is not technically required, filing one to adequately disclose the gifts can be wise.

8. Generation-Skipping Transfer (GST) Tax: Don't Ignore It

If your ILIT can benefit grandchildren or later generations, or if it keeps the insurance proceeds in trust for your children for their lifetimes, the trust may be subject to the separate 40% GST tax when assets eventually pass to grandchildren. The solution is to allocate part of your $15 million GST exemption to the trust so its "inclusion ratio" is zero and the trust is permanently exempt.

 

Here is the trap. Annual exclusion gifts to most ILITs do not automatically get a zero inclusion ratio under IRC §2642(c), because that special rule applies only to trusts for a single beneficiary. IRC §2632(c) automatically allocates GST exemption to some trusts but not others, and the outcome depends on the specific terms of your trust. The safest practice is for your accountant or attorney to file a timely Form 709 each year that affirmatively allocates GST exemption to your gifts to the ILIT, or that elects to treat the trust as a GST trust. Allocating exemption to small premium gifts now, while the trust holds little value, can shelter a much larger death benefit later.

9. Your ILIT Is Probably a "Grantor Trust" for Income Tax Purposes

Under IRC §677(a)(3), a trust is a grantor trust when its income may be used to pay premiums on insurance on the grantor's life (or the grantor's spouse's life). Most ILITs are therefore grantor trusts while you are alive. That means any taxable income the trust earns (for example, interest on a small bank balance) is reported on your personal Form 1040, not taxed to the trust.

 

Grantor trust status has nothing to do with estate tax. A trust can be a grantor trust for income tax purposes and still be completely outside your estate for estate tax purposes. Some ILITs also give the grantor a power to substitute assets of equal value under IRC §675(4)(C). In Revenue Ruling 2011-28 the IRS ruled that such a power does not, by itself, create an incident of ownership in a policy held by the trust, as long as the trustee has a fiduciary duty to make sure the substituted assets are of equal value. Grantor trust status ends when you die.

10. Your Spouse as Beneficiary or Trustee

Many ILITs let the trustee make distributions to the grantor's spouse during the spouse's lifetime and then pass the remainder to the children. If your spouse is both a beneficiary and the trustee, distributions to your spouse should be limited to an "ascertainable standard," which means health, education, maintenance and support. A broader discretionary power held by your spouse can cause the trust to be included in your spouse's estate. An independent trustee avoids that risk.

 

If your ILIT owns a second-to-die (survivorship) policy on you and your spouse, neither of you should serve as trustee or hold any incident of ownership, because both of you are insureds.

 

If you divorce, your former spouse may still be a beneficiary of an irrevocable trust. Review how your trust defines "spouse" and talk to your attorney immediately if your marriage ends.

11. Don't Require the ILIT to Pay Your Estate Taxes

A common purpose of an ILIT is to provide cash to pay the estate tax. But if the trust requires the trustee to pay your estate's taxes, debts or expenses, the proceeds used for that purpose are treated as receivable by your executor and are included in your estate under IRC §2042(1) and Treasury Regulation §20.2042-1(b). A well-drafted ILIT instead permits (but does not require) the trustee to buy assets from your estate or lend money to your estate at fair terms. That gives your estate the cash it needs without pulling the insurance back into the estate.

12. Coordinate the ILIT With the Rest of Your Estate Plan

Your ILIT is one piece of your plan. Your will, revocable living trust, financial power of attorney and beneficiary designations must all be consistent with it. Specifically:

• Make sure your financial power of attorney does not authorize your agent to deal with the ILIT's policy or to make unlimited gifts that could create incidents of ownership.
• Tell your executor and successor trustee of your revocable trust that the ILIT exists, who the ILIT trustee is, and where the trust documents are kept.
• Give your CPA a copy of the ILIT so gift tax returns and GST allocations are handled correctly every year.
• Do not buy new insurance on your life in your own name. If you want more coverage, have the ILIT trustee apply for it.

13. Revisit the Plan as the Law Changes

With a $15 million per person exemption, many families no longer have a taxable estate. If your net worth is near or above the exemption, or if you expect it to grow, an ILIT remains one of the most efficient ways to deliver a large tax-free benefit to your family. Review your plan with your attorney every few years, after any major change in your net worth, and after any change in the federal estate tax law. If the ILIT is no longer needed, there may be ways to reduce or restructure it without violating the rules.

Part 2: What the Trustee Must Know to Comply With Federal Tax Law

If you agreed to serve as trustee of an ILIT, you are a fiduciary. You owe the beneficiaries duties of loyalty, prudence and impartiality under the Arizona Trust Code, and you are responsible for following the federal tax rules that keep the insurance out of the grantor's estate. You can hire an attorney and a CPA to help, but the responsibility is yours. Keep in mind that you take your instructions from the trust document, not from the grantor.

1. Get a Taxpayer Identification Number (EIN)

Apply for an employer identification number for the trust using IRS Form SS-4 or online at irs.gov. Use the exact trust name from the trust agreement. Even though most ILITs are grantor trusts while the grantor is alive, insurance companies and banks generally require a trust EIN, and having one from the start makes the trust's separate existence clear. Your CPA will decide which grantor trust reporting method the trust uses under Treasury Regulation §1.671-4.

 

You may also file IRS Form 56, Notice Concerning Fiduciary Relationship, to tell the IRS you are acting as trustee so that IRS notices come to you.

2. Open a Separate Trust Bank Account

Open a checking account titled in the name of the trust, using the trust's EIN, with you signing as trustee. Every gift from the grantor goes into this account and every premium is paid from this account. Never commingle trust money with your own money or the grantor's money, and never pay a premium from your personal account. The bank statements become your best proof that the trust, not the grantor, paid for the insurance.

3. Apply for and Own the Policy

When the trust buys a new policy, you as trustee sign the application as the owner. The application and the policy must show:

• Owner: "[Name], Trustee of the [Trust Name] dated [date]."
• Beneficiary: the same trustee designation. Never the grantor's estate, spouse or children individually.
• Insured: the grantor (or the grantor and spouse for a survivorship policy).

If the grantor transferred an existing policy, get written confirmation from the insurance company that the ownership and beneficiary changes were recorded, and get Form 712 showing the policy's value on the date of the transfer for the grantor's gift tax return. Keep a copy of the policy itself in the trust records. Sign every policy form yourself. Never let the grantor sign anything as owner.

4. Send Crummey Notices Every Time the Trust Receives a Gift

This is the trustee's most frequently overlooked job, and missing it can cost the grantor the annual exclusion. Each time the grantor gives money to the trust, you must promptly send each beneficiary who holds a withdrawal right a written notice that:

• States that the trust received a gift, the date of the gift, and the amount.
• States the amount the beneficiary has the right to withdraw.
• States the deadline to exercise the right (usually 30 days after the notice, or whatever period the trust requires) and how to exercise it.

For a minor beneficiary, send the notice to the minor's parent or legal guardian (other than the grantor, if the trust so provides). Many trusts require the notice to go to a guardian or someone else who can act for the minor. Follow your trust's specific instructions.

 

Ask each beneficiary to sign and return an acknowledgment that he or she received the notice. The acknowledgment should confirm receipt only. It must not say the beneficiary waives the right to withdraw or promises not to withdraw. Keep copies of every notice and every signed acknowledgment permanently. If the IRS ever audits the grantor's gift tax or estate tax return, these are the documents that prove the annual exclusion was valid.

 

Some trusts allow the beneficiaries to sign a one-time notice covering all future gifts. Whether that is sufficient is debated, and the safer practice is to send a notice for every gift.

5. Honor Any Withdrawal Request

If a beneficiary exercises a withdrawal right within the deadline, you must pay that beneficiary the amount he or she is entitled to withdraw. That is what makes the Crummey power real. Do not pay the premium until the withdrawal period has expired, unless the trust has enough cash to honor every outstanding withdrawal right and pay the premium.

6. Pay the Premiums on Time From the Trust Account

After the withdrawal period expires, pay the premium from the trust account by check or transfer to the insurance company. Calendar every premium due date and grace period. A missed premium can cause the policy to lapse, and a lapsed policy on an older or less healthy insured may be impossible to replace. If the grantor has not given you enough money to pay a premium, tell the grantor in writing well before the due date. You cannot force the grantor to make gifts, but you should make sure the grantor understands the consequences.

7. Monitor the Policy at Least Once a Year

A life insurance policy is a trust asset, and you have a duty to manage it prudently. At least once a year:

• Get the annual policy statement and confirm the owner and beneficiary designations are still correct.
• For universal life and other flexible-premium policies, request an "in-force illustration" from the insurer showing whether the current premium will keep the policy in force to the insured's life expectancy and beyond. Rising insurance costs or lower-than-projected interest credits can cause a policy to run out of money years before the insured dies.
• Consider whether the policy is still competitive, and get professional advice before replacing it. If the policy is exchanged for another policy, the exchange should be structured as a tax-free exchange under IRC §1035, and the new policy must be owned by the trust from the start.
• Do not take policy loans or cash-value withdrawals to benefit the grantor, and never let the grantor direct how the policy is managed.

8. Keep Complete Records

Keep a permanent trust file that contains the signed trust agreement and any amendments or decanting documents, the EIN letter, the policy and all policy statements, every gift letter from the grantor, every Crummey notice and acknowledgment, all bank statements, all premium payment records, and copies of all tax returns. Under A.R.S. §14-10813 you also have a duty to keep the qualified beneficiaries reasonably informed about the trust and its administration, and to respond to their reasonable requests for information.

9. Federal Income Tax Returns During the Grantor's Life

While the trust is a grantor trust, its income is reported on the grantor's personal return. Depending on the reporting method your CPA chooses, the trust may file a "grantor type" Form 1041 with an attached statement or use an optional method that does not require a Form 1041. If the trust is not a grantor trust (some ILITs are drafted that way), the trustee must file IRS Form 1041 for any year in which the trust has gross income of $600 or more, or any taxable income, under IRC §6012(a)(4). Most ILITs hold only enough cash to pay premiums, so the trust's income is usually small, but the filing requirement still applies.

10. Act Independently

The grantor will often have opinions about the trust, and it is fine to listen. But you, not the grantor, make the decisions. Do not take instructions from the grantor about changing beneficiaries, borrowing against the policy, surrendering the policy, or distributing trust assets. If the IRS concludes that the grantor actually controlled the policy through the trustee, it can argue the grantor held incidents of ownership. Document your own decisions in writing.

The ILIT Annual Compliance Calendar

What the Trustee Does When the Grantor Dies

When the grantor dies, the ILIT does what it was built to do. The trustee's job changes from paying premiums to collecting and managing what is often a very large sum of money.

1. Collect the Death Benefit

Get several certified copies of the death certificate and submit a claim to the insurance company as trustee. The death benefit is paid to the trust free of federal income tax under IRC §101(a). Interest the insurer pays for the period between the death and the payment is taxable income to the trust. Deposit the proceeds in the trust's account, not the estate's account and not a beneficiary's account.

2. Get Form 712 and Cooperate With the Executor

Ask the insurance company for Form 712, Life Insurance Statement, for every policy the trust owned on the grantor's life. If the grantor's estate must file a federal estate tax return (Form 706, due nine months after death under IRC §6075), the return asks whether there were policies on the decedent's life that are not included in the gross estate, and the executor must attach Form 712 for those policies. Give the executor what he or she needs. Executors often file Form 706 even when no tax is due to elect "portability" of the deceased spouse's unused exemption to the surviving spouse.

3. Provide Liquidity to the Estate the Right Way

If the estate needs cash to pay estate tax or other expenses, the trustee may use the trust's money to buy assets from the estate at fair market value or to lend money to the estate at a fair interest rate, if the trust allows it. Do not simply pay the estate's bills. A gift from the trust to the estate, or a payment the trust was required to make, can pull the proceeds back into the estate.

4. The Trust Becomes a Separate Taxpayer

Grantor trust status ends at the grantor's death. From then on the trust is a separate taxpayer that must use its own EIN (get one now if the trust did not already have one) and file Form 1041 each year it meets the filing threshold. Trusts reach the top 37% federal income tax bracket at only about $16,000 of retained taxable income, and may also owe the 3.8% net investment income tax under IRC §1411. Income that is distributed to beneficiaries is generally taxed to the beneficiaries instead, who receive Schedule K-1s. Your CPA can help you decide whether distributions make sense.

5. Invest Prudently and Follow the Trust's Distribution Instructions

Arizona's prudent investor rule, beginning at A.R.S. §14-10901, requires the trustee to invest and manage trust assets as a prudent investor would, considering the purposes, terms, distribution requirements and other circumstances of the trust. That generally means a diversified portfolio rather than leaving millions of dollars in a checking account. Then follow the trust's instructions exactly: some ILITs distribute everything outright to the children, while others keep the money in lifetime trusts that protect it from the beneficiaries' creditors and divorces.

6. Keep GST-Exempt Assets Separate

If GST exemption was allocated to the trust and its inclusion ratio is zero, keep it that way. Do not mix GST-exempt assets with non-exempt assets, and talk to your CPA before making distributions to grandchildren or more remote descendants.

The 15 Mistakes That Can Destroy an ILIT

1. The grantor serves as trustee or co-trustee.
2. The grantor signs a policy form as owner.
3. The policy's owner or beneficiary is never changed to the trustee.
4. The grantor borrows against the policy.
5. The grantor dies within three years after transferring an existing policy to the trust.
6. The grantor pays premiums directly to the insurance company.
7. The trustee never sends Crummey notices.
8. The trustee pays the premium before the withdrawal period expires, with no money left to honor a withdrawal.
9. The family has an understanding that nobody will ever exercise a withdrawal right.
10. The grantor's gifts exceed the available annual exclusions and no Form 709 is filed.
11. No GST exemption is allocated to a trust meant to last for generations.
12. The trust requires the trustee to pay the estate's taxes.
13. The trust money is commingled with the trustee's or grantor's personal money.
14. A premium is missed and the policy lapses.
15. The trustee follows the grantor's instructions instead of the trust agreement.

ILIT Frequently Asked Questions

Does an ILIT avoid probate?

Yes. The trust is the beneficiary of the policy, so the death benefit is paid directly to the trustee and never passes through the grantor's probate estate.

Can my spouse be the trustee of my ILIT?

Your spouse can serve as trustee if the trust limits your spouse's discretionary distributions to himself or herself to health, education, maintenance and support, and if your spouse is not also an insured under the policy. An independent trustee is usually the safer choice.

Can my adult child be the trustee?

Yes. Adult children frequently serve as ILIT trustees. A child who is also a beneficiary must still follow the trust terms, send Crummey notices to himself or herself and the other beneficiaries, and act impartially toward all of the beneficiaries.

Do I have to file a gift tax return every year?

Not necessarily. If every gift to the trust qualifies for the annual exclusion through properly administered Crummey powers, no return may be required. But you must file Form 709 if your gifts exceed the available exclusions, if you split gifts with your spouse, or if you need to allocate GST exemption. Many advisors recommend filing every year for an ILIT intended to benefit grandchildren.

What happens if the trustee forgets to send a Crummey notice?

The IRS can argue the gift was a future interest that does not qualify for the annual exclusion. That would use part of the grantor's lifetime exemption and may require a gift tax return. If you discover a missed notice, contact your attorney and CPA promptly.

Is the death benefit subject to income tax?

Generally no. Under IRC §101(a), life insurance proceeds paid because of the insured's death are excluded from gross income. Interest paid on delayed proceeds is taxable, and a policy acquired in a "transfer for value" can lose part of the exclusion.

Can the ILIT own a policy on both me and my spouse?

Yes. A second-to-die (survivorship) policy pays when the second spouse dies, which is usually when the estate tax is due. Neither spouse should serve as trustee or hold any incident of ownership in a survivorship policy.

What if I no longer need the ILIT because the exemption went up?

You cannot revoke the trust, but you can stop making gifts. The trustee may then reduce the death benefit, use the cash value to pay premiums, convert the policy to a reduced paid-up policy, or in some cases decant the trust under Arizona law. Every option has tax consequences, so get advice before acting.

Does Arizona have an estate tax?

No. Arizona has no state estate tax or inheritance tax. The ILIT is designed to reduce the federal estate tax.

Are You Interested in an Irrevocable Life Insurance Trust?

Arizona estate planning attorneys Richard Keyt, who has practiced Arizona law since 1979, and his son, attorney and former CPA Richard C. Keyt, help Arizona families reduce federal estate tax, avoid probate and protect their children's inheritances. We prepare irrevocable life insurance trusts.

 

To get started, book a free office, phone or Zoom video consultation. You can contact Richard Keyt (the father) at 480-664-7478 & rk@keytlaw.com or Richard C. Keyt (the son) at 480-664-7472 & rck@keytlaw.com.

 

This article provides general information about federal tax law and Arizona trust law as of 2026. It is not legal or tax advice for your specific situation. Every ILIT is different; the trustee and grantor should follow the terms of their own trust agreement and consult their attorney and CPA. © 2026 KEYTLaw, LLC.