A Step-By-Step Guide to Setting Up an Irrevocable Life Insurance Trust

As we wrote about in our last blog post, an Irrevocable Life Insurance Trust (ILIT) is one of the most effective tools for protecting wealth and creating long-term financial security.

An irrevocable life insurance trust is a specific type of life insurance trust that holds a life insurance policy for your benefit and your family’s protection. The trust, not you, owns the policy. When you pass away, the insurance proceeds go to the trust instead of your estate, which can help reduce potential estate taxes and simplify how the funds are passed to your heirs. The Internal Revenue Service notes that when a person does not own or control their policy, the proceeds are generally excluded from their taxable estate.

With this in mind, you can see why there are many strong reasons for you to set up this trust with Studemont Group, LP.

ILITs deliver:

• Wealth protection from creditors

• Intentional legacy planning to ensure proper asset usage

• Tax savings and exemptions

How Your ILIT Works

Think of an ILIT as a separate financial home built to hold your life insurance policy safely outside your estate. In life insurance estate planning, that separation matters because it helps keep the death benefit protected from estate taxes and creditors while avoiding delays in probate.

When you create this type of estate-planning trust, you transfer ownership of the insurance policy into the trust. From that point, the trust owns the policy, not you. The trustee manages the policy and pays premiums with the funds you contribute while following Internal Revenue Service rules so the structure stays compliant. The result is a legally distinct entity that controls and eventually receives the life insurance proceeds.

Get Your ILIT Started The Right Way

To help you begin the process of establishing an ILIT,  we’ve outlined the essential steps below. Please note that this is general and educational information. ILITs involve legal and tax implications, so it’s important to work with a qualified estate-planning attorney before taking action.

With that in mind, here’s what it takes to set up your trust:

1. Ensure an ILIT Is Right for You

Before creating an ILIT, speak to your attorney and make sure it aligns with your goals. ILITs are commonly used to:

• Remove life insurance proceeds from your taxable estate

• Provide liquidity for estate expenses

• Protect assets from creditors

• Control how beneficiaries receive funds

• Provide for minors or spendthrift beneficiaries

If these goals match yours, then take the next step.

2. Choose a Trustee

Understand that you absolutely cannot be the trustee. 

This is paramount to setting up the trust, and is why the trust is able to operate as it does. Since the trust must be irrevocable and outside your control, you must choose the trustee. The trustee can be:

• A trusted family member

• A professional trustee from a bank, a trust company, or a practicing attorney

The trustee handles premium payments, Crummey notices, and policy management. Before choosing your trustee, make sure they are willing and capable of performing these duties.

3. Draft the ILIT Agreement with an Estate-Planning Attorney

Your estate-planning attorney will work with you to prepare the ILIT document, which includes:

• The name of the trust

• The trustee appointment

• All beneficiaries

• Distribution rules

• Rules for managing insurance policies

• Crummey withdrawal provisions, which are for gift-tax compliance

Once you have signed this document, the trust will become its own legal entity, operating under the control of the trustee. 

4. Obtain an EIN (Employer Identification Number) for the ILIT

The first act the trustee will need to perform is to apply for and obtain an EIN through the IRS website. This is imperative as it is required to open a bank account and manage trust taxes.

5. Open a Bank Account in the Trust’s Name

Once the EIN has been obtained, the trustee, not you, will need to open a bank account in the trust’s name by using:

• The ILIT agreement

• The trustee’s identification

• The trust’s EIN

This will be the official account that will receive your gifts, which are in turn used to pay insurance premiums.

6. Fund the ILIT

The trust is usually funded through annual gifts from you, now referred to as “the grantor,”  to the trust.

The most common funding methods are:

Option A: The ILIT buys a new life insurance policy

• This is where you gift money to the trust.

• The trustee then uses those funds to pay premiums.

  
  

Option B: You transfer an existing life insurance policy into the ILIT

If you choose this option, you must be aware of the 3-year rule: If you die within 3 years of transferring an existing policy, it may still be included in your taxable estate.

7. The Trustee Sends Crummey Notices

Before we get into this step, it’s important to familiarize yourself with Crummey notices. 

A Crummey notice is a formal notification sent to beneficiaries of an irrevocable trust, informing them that a gift has been made and granting them a temporary right to withdraw the contribution for a specified period, typically 30 to 60 days. This process allows the gift to qualify for the annual federal gift-tax exclusion by transforming a future gift into a "present interest". If the beneficiary does not exercise their withdrawal right, the funds remain in the trust and are managed according to its terms. 

With that in mind, anytime you make a gift to the trust:

1. The trustee must notify beneficiaries that they may withdraw the gifted amount.

2. Beneficiaries typically do not withdraw it.

3. After the waiting period (usually closer to 30 days), the trustee uses the funds to pay premiums.

   
   

This step is crucial to comply with gift-tax laws.

8. The Policy and the Trust are now Fully Managed by the Trustee

Now that the trust is up and running, a legal entity of its own, and funded, control of the trust lies solely in the hands of the trustee. As such, the trustee handles:

• Payment of premiums

• Monitoring the insurance policy

• Record-keeping

• Filing tax forms (if required)

• Maintaining Crummey notices

Be aware that you cannot legally direct investments or control the trust.

9. The Final Act: Upon Your Death, the ILIT Receives Your Life Insurance Proceeds

Because the ILIT now owns your policy, the death benefit:

• Is not included in your taxable estate

• Can be used to provide liquidity (e.g., for estate taxes)

• Is distributed according to the trust terms

• Can be held in trust and protected from creditors

  
  

Moving Forward: Important Legal Notes

Now that we’ve laid out the basic steps for setting up your ILIT, before you move forward, be aware that:

• An ILIT cannot be modified after creation (with very limited exceptions).

• You must avoid “incidents of ownership” over the policy.

• Crummey notices are legally required to avoid gift-tax issues.

• Estate-planning attorneys usually coordinate these steps for you.

As you prepare to get started, be very sure to meet with your attorney to create a legally sound trust from the start.

Please note that Studemont Group, LP is not a legal firm and does not offer legal advice. We advise you to consult with your attorney, and we will coordinate with your counsel in creating and executing your ILIT strategy.