Episode 76: Why Your Life Insurance Trust Might Not Work
Episode 76
Host: Jill Mastroianni
Why Your Life Insurance Trust Might Not Work
New clients came in with two life insurance trusts—professionally drafted, signed, notarized, and organized in beautiful binders. There was just one problem: the trusts didn’t do anything.
In this episode, Jill breaks down what an irrevocable life insurance trust (ILIT) is, when it actually makes sense, and how it fails when no one follows through. This is a real-life look at the gap between having documents and having an estate plan that actually works.
What You’ll Learn in This Episode
What an irrevocable life insurance trust (ILIT) actually does
Why ILITs are primarily used to address estate tax
The current federal estate tax exemption and why most people don’t need an ILIT
The difference between estate tax and estate income tax (Form 706 vs. Form 1041)
Why “setting up” a trust is not the same as “funding and administering” it
The key questions to ask about any life insurance policy: Who owns it? Who is the beneficiary?
Why an ILIT that isn’t connected to the policy is just a stack of paper
What’s actually involved in creating and maintaining an ILIT
How gift tax rules apply when funding a life insurance trust
What Crummey letters are and why they matter
Why serving as trustee is a real job, not just a title
How the “trust recession” is changing the way people approach estate planning
Resources & Links
Watch this episode on YouTube: https://youtu.be/JaE0tkaacoU
Episode 5, Why you shouldn’t worry about the estate tax: https://www.deathreadiness.com/podcast/why-you-shouldnt-worry-about-the-estate-tax
Get your copy of The Death Readiness Playbook: www.deathreadiness.com/playbook
Connect with Jill:
Website: DeathReadiness.com
Email: jill@deathreadiness.com
Learn more about Jill’s solutions
Subscribe to the Death Readiness Dispatch!
Ask a question for Tuesday Triage
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New clients came to me with two life insurance trusts—professionally drafted, signed, notarized, and arranged in beautiful binders. There was just one problem. The trusts didn’t do anything. Today, I break down what an irrevocable life insurance trust is, when it actually makes sense, and how it fails when no one follows through.
Welcome to The Death Readiness Podcast. This is not your dad’s estate planning podcast. I’m Jill Mastroianni — estate planning attorney, death readiness guide, and your translator for wills, trusts, probate, and the conversations most families avoid. If you’ve been wondering things like, ‘Can a trust protect what I leave to my children?’ ‘What happens if I give someone power of attorney over me?’ and ‘How can I help my parents while respecting their independence?’ You’re in the right place.
Soon after my husband Jeremy and I got married, we added an extension onto our ranch home. It was a new primary bedroom and bathroom. We were getting ready to grow our family, and this felt like the right next step.
I hired a contractor on the recommendation of a close friend. I had seen his work, my friend was happy, he showed up when he said he would. It all looked and felt right. And at the time, I thought he did the job we hired him to do.
We spent about $100,000 on this 500-square-foot addition. It wasn’t cheap, but it made sense. We loved our house, we loved the location along Nashville’s greenway, and the addition felt like a smarter move than buying something bigger.
We also loved the addition – a high vaulted ceiling, a screen-in back porch and a walk-in closet.
But then, over time, things started to unravel. The structure wasn’t done correctly, and as the frame settled, new cracks kept showing up across the drywall.
When we were getting ready to sell, we decided to get a professional opinion on cracks in the walls and other issues that didn’t sit right. We could have patched over the cracks and left the problem to the new owners.
But that didn’t feel right to us.
So we brought in a structural engineer, got a clear assessment of what was actually going on, and hired a different contractor to fix it the right way. That ended up costing us another $70,000.
And that money mattered. We still had student loans, two kids, and too many dogs.
But it was important to us not to pass along a problem to someone else. And as far as I know, the new owner is really happy with the house.
I think about that experience a lot when I hear people talk about what’s now being called a “trust recession.” A trust recession is simply a loss of confidence. We trust institutions and professionals less than we used to. We’ve seen enough things go wrong that we don’t just take someone’s word for it anymore.
We double check medical advice. We second-guess financial recommendations. It’s this constant feeling of, “I think this is right… but I’m not really sure.”
And when that happens, we can’t just rely on guidance. We feel like we have to figure everything out ourselves.
In estate planning, that shows up in a really specific way.
People don’t just want documents. They want to understand what those documents are doing. And they want to feel confident that they’re actually going to work when it matters.
Because sometimes things look right… until they don’t.
I hope this podcast helps you ask better questions, and helps you know whether the person you’ve trusted, and paid, to help you actually got it right.
That’s also exactly why I created The Death Readiness Playbook.
It’s not just a place to write things down. It’s a way to learn, step by step, how your life is set up, what matters, and what someone else would need to step in.
Confidence doesn’t come from having documents. It comes from understanding them.
You can learn more at deathreadiness.com/playbook. That’s deathreadiness.com/playbook.
And now, for today’s Tuesday Triage question:
What is an irrevocable life insurance trust and do you actually need one?
I was working with clients recently as part of an estate plan audit. That’s where I review existing documents, explain what they actually do, how they work in real life, and then we figure out together whether anything needs to change. I offer these estate plan audits to individuals nationwide.
This particular couple asked me to review two trusts, both irrevocable life insurance trusts. You’ll usually hear those called ILITs—that’s I-L-I-T.
Now, here’s a quick side note because this confused me the first time I heard it.
There’s another kind of “eyelet”—spelled E-Y-E-L-E-T—which is the little reinforced hole your shoelaces go through.
Of course, it’s a different thing entirely.
But that’s where my brain went the first time I heard “ILIT” as part of an estate planning conversation so I’m just making sure we’re all on the same page.
So what is an ILIT?
At a high level, it’s a trust that owns your life insurance policy. Not you—the trust. More specifically, the trustee of the trust becomes both the owner of the policy and the beneficiary of the policy.
So why would anyone want to do that?
The main reason is to avoid the federal estate tax. If the trust is set up and administered properly, and that part really matters, the life insurance proceeds can be kept out of your taxable estate, which may reduce estate taxes.
And I’m emphasizing “set up and administered properly” because signing the document is not enough. If the trust isn’t actually used the way it’s supposed to be, it doesn’t work.
The trust is irrevocable, meaning once you set it up and transfer the life insurance policy, you don’t get to take it back. You don’t get to change the terms. You’re giving up control in exchange for the estate tax benefit.
So yes, this can be a really powerful tool.
But it has to be used in the right situation.
ILITs are really only useful for people whose estates are large enough to be subject to estate tax.
And that’s a very small percentage of people.
I’ll link in the show notes to Episode 5—Why you shouldn’t worry about the estate tax—if you want a deeper dive. But let me give you a quick primer so we’re all on the same page.
Right now, the federal estate tax exemption is $15 million per person. That means if I die this year and everything I own is worth $15 million or less, my estate doesn’t owe any federal estate tax.
And just to be clear, I’m talking about the federal estate tax, not the income tax.
Even if an estate doesn’t owe estate tax and doesn’t have to file a federal estate tax return, a Form 706, it may still have to file a different return, an estate income tax return, or Form 1041.
That’s an income tax return for the estate itself. If the estate earns income during administration, things like investment income, rental income from an investment property, anything like that, that income still has to be reported.
So even when estate tax isn’t an issue, income tax can still come into play. I wanted to make sure to include that distinction between federal estate tax and income tax payable by an estate because that can be really confusing to people.
Okay, let’s get back to ILITs – irrevocable life insurance trusts.
I live in Michigan, and we don’t have a state-level estate tax here so the only estate tax I might be worried about is the federal estate tax.
Would an ILIT be helpful to me?
The first question is: do I have life insurance?
Yes. I have a $1 million life insurance policy.
The second question is: do I need an ILIT to keep that $1 million out of my taxable estate and avoid federal estate tax?
For me, the answer is no, absolutely not.
My estate is well below the current $15 million federal estate tax exemption. So even if the proceeds from that $1 million policy are included in my taxable estate, it does not create an estate tax problem for me.
Could the law change? Of course. If the estate tax exemption dropped dramatically, say from $15 million to $500,000, then my answer might change. In that world, an ILIT might become a useful part of my estate plan.
But I can only plan based on the information I have now. And right now, I should not be worrying about federal estate tax.
Whenever I’m asked to review an ILIT, the first thing I ask my client to do is confirm two things with the insurance company:
Who owns the life insurance policy?
And who is the beneficiary of the policy?
That matters because an ILIT only works if the trust is actually connected to the policy.
Otherwise, the ILIT may be nothing more than a very official-looking stack of paper.
And this is where people get into trouble.
Creating an ILIT is one thing. Funding it and administering it correctly is another. It requires multiple people, some professionals, some non-professionals, doing very specific things in the right order for the plan to actually work.
So even though I’ve just told you I don’t need an ILIT, let’s pretend I decide to create one anyway, just so you can see what the process looks like.
Fair warning: this next part gets detailed.
But stay with me, because this is the part that shows why these trusts can be powerful when they’re done right—and completely useless when they’re not.
And, because I believe in rewarding people who hang in there through detailed estate planning explanations, I’m offering a prize at the end.
So don’t bail on me now.
First, I would have to create the trust.
I’d be the grantor, the person setting it up. I’d name my friend Lauren as the trustee, the person who would administer the trust, and my husband and my two kids as the beneficiaries.
Now remember, this trust is irrevocable. That means I generally can’t change it later, and I have to give up control. Because if I keep too much control over the trust, or the life insurance policy, it could get pulled right back into my taxable estate, which defeats the whole purpose.
So step one: create the trust and give up control.
Step two: figure out what I’m actually transferring into the trust.
Step three: Name the trust as the beneficiary of my life insurance policy.
I’m going to transfer my life insurance policy and the next few premium payments into the trust. My life insurance policy is a term policy. A term life insurance policy covers you for a specific period of time—your “term”—like 10, 20, or 30 years. If you die during that term, the policy pays a set amount of money to your beneficiary. If you outlive the term, the coverage ends and there’s no payout so it’s not worth very much. But the IRS still cares about its value because I’m making a gift when I transfer it to the trust.
Now, how do you value a life insurance policy?
It’s not intuitive. For a term policy, you have to get something called the interpolated terminal reserve value from the insurance company, and then add any unpaid premiums.
Once I have that value, I transfer the policy to the trust. At that point, Lauren, as trustee, becomes the official owner.
But we’re not done. I know this is technical but stick with me a bit longer for that prize I mentioned earlier.
The life insurance policy still has premiums that need to be paid.
So I also need to gift cash to the trust so it can cover those premiums, at least for the near term.
And that means Lauren, as trustee, now has another job: she has to open a bank account for the trust to hold that money.
So now we have a trust, a transferred policy, and a bank account.
Let’s say that between the value of the policy and the cash I contributed, I’ve made a total gift of $30,000 to the trust.
And now we’ve got a new issue.
I just gave away $30,000.
And when you make gifts during your lifetime, those gifts are subject to gift tax rules.
Now, there is some breathing room here. In 2026, you can give up to $19,000 per person, per year, without having to report it.
Anything above that, you may have to report on a federal gift tax return, a Form 709.
That doesn’t necessarily mean you owe tax. It just means the IRS is keeping track.
Because remember, you have that $15 million exemption. So if this $30,000 gift is the first gift I’ve ever made, I’m not writing a check to the IRS. I’m just using up a small portion of that exemption.
But the IRS still wants to know about it.
So now the question becomes: do I have to file a gift tax return?
Because I gave $30,000. And the annual exclusion is $19,000 per person.
So who did I actually give that money to?
Was it the trust? Was it Lauren, the trustee?
Or was it the beneficiaries, my husband and my kids?
Technically, I transferred the policy and wrote the check to Lauren as trustee. But the money isn’t for her. It’s to pay the premiums on the life insurance policy.
So is there a way to treat that $30,000 as if it were split between multiple people—so that each portion falls under that $19,000 annual exclusion?
And if we can do that, can we avoid having to file a gift tax return altogether?
Well…yes, there is a way.
Here’s how it works.
Lauren, as trustee, is going to send a letter to each of the beneficiaries—my husband Jeremy, my son Travis, and my daughter April. Since April is a minor, her letter goes to Jeremy on her behalf.
In that letter, Lauren tells them two things:
One, you’re a beneficiary of this trust.
And two, a contribution was just made to it.
Now, when I set up the trust, I included something called withdrawal rights in the terms of the trust agreement. That means whenever I make a gift to the trust, the beneficiaries technically have the right to take that money out.
So Lauren’s letter says: a contribution was made, and you have the right to withdraw your share.
And then she asks them to sign and return the letter, confirming whether they want to take the money.
Now, let’s be honest about what’s actually happening here.
This is done with a bit of a wink and a nod.
Because if Jeremy or Travis or April actually took the money out, there wouldn’t be any money left in the trust to pay the insurance premiums.
So they don’t take it.
But the fact that they could have taken it is what matters.
Because that turns the gift into what’s called a present-interest gift and that’s the type of gift that qualifies for the annual exclusion.
So if we go through all of this, it’s as if I made three separate $10,000 gifts, one to each of them, instead of one $30,000 gift.
And now we’re under the $19,000 limit per person.
But we’re not done.
Lauren has to send those letters, collect them back, and keep them with the trust records. Because if the IRS ever comes knocking, they’re going to want proof that this process actually happened.
And she has to do this every single time I contribute money to the trust to pay premiums.
By the way, these are called Crummey letters—C-R-U-M-M-E-Y—named after the 1968 case, D. Clifford Crummey v. Commissioner of the IRS that blessed this whole structure.
So yes, there is a way to make this work.
But it’s not simple. And it’s definitely not passive.
And what about my friend Lauren?
She works full time. She has young, active kids. Does she really want to be tracking deadlines, sending letters, following up when people don’t respond, keeping records, and making sure insurance premiums get paid on time?
And more importantly, do I really want her responsible for all of that? Because that’s what I’m asking.
And I chose Lauren on purpose. Because that’s what most people do.
They don’t pick a professional trustee because that costs money.
They pick a friend, a sibling, an adult child, an uncle.
And I understand that instinct, I really do.
But we have to be honest about what we’re asking. This isn’t just a title. It’s also a job. And it’s not a simple one.
So let’s go back to the couple who asked me to review their ILITs.
Remember the first two questions I always ask:
Who owns the policy?
And who is the beneficiary of the policy?
They went back to the insurance company and sent me the documentation.
The owner of each policy was the insured spouse.
And the beneficiary of each policy was the other spouse.
That’s exactly the way my life insurance is set up.
Earlier, I told you I have a $1 million policy. I own it. My husband is the beneficiary. I don’t have an ILIT.
This couple had two ILITs. So why did they have the same setup I do?
Because what they actually had were two binders of paper.
The documents were signed and notarized with a color diagram showing how everything was supposed to work.
And none of it was ever connected to the life insurance policies.
So the trusts didn’t do anything.
The professionals they trusted to set it up correctly and give them the right instructions just gave them something that looked good but wasn’t structurally sound, kind of like the beautiful bedroom that was added to our previous home almost 10 years ago.
They paid for a plan to remove their life insurance from their taxable estate.
What they got…were two stacks of paper.
There are a few things I hope you take away from today’s episode.
First, yes—we are in a trust recession. And I actually think that’s a good thing.
If you’re listening to this podcast, you’re trying to educate yourself. I don’t want you drafting your own estate plan. But I do want you asking better questions—and expecting follow-through from the professionals you hire.
Second, before you ask your best friend to serve as trustee, understand what you’re asking them to do. This isn’t just a title. It’s responsibility, risk, and ongoing work.
And third, ILITs can be incredibly powerful tools when they’re used in the right situation and implemented correctly. But my experience is that they’re often done wrong, in situations where they weren’t needed to begin with.
If you’ve made it this far with me, thank you. I really do hope this helped you understand how life insurance trusts work in real life, not just on paper.
And as promised, I’ve got a little reward for you.
I’m giving away 5 free copies of the second edition of The Death Readiness Playbook to the first 5 listeners who email me at jill@deathreadiness.com with “Playbook” in the subject line. Send me your name and mailing address, and I’ll get one out to you this week.
And even if you’re not one of the first five, I’ll still send you something as a thank you for being here.
This is the updated version of the Playbook—and it’s designed to help you understand how your life actually works, not just fill out forms. It also comes with a separate workbook of key worksheets, so you don’t have to write in your beautiful book.
Because this isn’t just about having everything in one place.
It’s about your family not having to guess.
You can learn more about The Death Readiness Playbook—and co-branding options for professionals—at deathreadiness.com/playbook. That’s deathreadiness.com/playbook
Thanks for listening today.
This is Death Readiness, real, messy and yours to own. I’m Jill Mastroianni and I’m here to help you sort through it, especially when you don’t know where to start.
Hi, I'm April, Jill's daughter. Thanks for listening to The Death Readiness Podcast. While my mom is an attorney, she’s not your attorney. The Death Readiness Podcast is for educational and entertainment purposes only. It does not provide legal advice. For legal guidance tailored to your unique situation, consult with a licensed attorney in your state. To learn more about the services my mom offers, visit DeathReadiness.com.
