The single richest source of settleable policies in an Illinois estate planning practice is the irrevocable life insurance trust holding coverage bought to pay a federal estate tax the client will no longer owe. Those trusts were drafted against exemption levels that no longer apply, the grantor has quietly stopped funding the Crummey gifts, and the trustee is watching the policy drift toward lapse with nobody willing to be the one who says so out loud.
That is a drafting-and-administration problem before it is a market problem. This page is written for the practitioner: how to recognize an over-insured trust, the tax mechanics that govern the disposition, what Illinois’s own estate tax does to the analysis, and how to get a policy valued without committing your client to anything.
Pine Lake Life Solutions provides education and free policy reviews. Nothing on this page is legal, tax, or investment advice, and none of it substitutes for your own analysis or your client’s independent counsel. Questions: (305) 209-7183.
In This Article
- Grantor Fatigue: The Trigger You Will Actually See
- The Over-Funded ILIT After the Federal Exemption Changes
- The Trustee’s Options When the Premium Stops
- Tax Mechanics You Should Know Before the Client’s CPA Asks
- Transfer-for-Value and the Three-Year Rule
- Fitting Proceeds Back Into the Plan
- How a Referral Works
- Compliance Note for the File
- Frequently Asked Questions
Grantor Fatigue: The Trigger You Will Actually See
Almost no client calls to say the ILIT no longer makes sense. What happens instead is that the annual exclusion gift arrives late, then partially, then not at all. The trustee sends the Crummey notices anyway. The policy starts consuming accumulated value to pay cost of insurance. Two or three years later somebody opens the in-force illustration and discovers the coverage lapses at age 84 rather than maturing.
Estate planners see the early version of this — a client who says, in passing, that the insurance premium has become annoying. That sentence is the intake trigger. The question worth asking next is not whether the client can afford the premium, but whether the death benefit still buys anything the client wants. If it was purchased to create liquidity for an estate tax that is no longer projected, the honest answer is often no.
Redacted cover page, sent with the client’s permission, is all it takes to find out what the policy is worth to the market. Free, one to two business days, no obligation.
The Over-Funded ILIT After the Federal Exemption Changes
Policies sold in the 1990s and 2000s were frequently sized against exemption amounts a fraction of today’s. Federal exemption levels rose sharply under the 2017 Tax Cuts and Jobs Act and were extended by subsequent legislation; as of 2026, confirm the exact current federal basic exclusion amount and the applicable inflation adjustment before you quote a number to a client. The direction is not in doubt even if the digits are: a very large share of trust-owned coverage now insures against a liability the family will never incur.
Illinois complicates this in a way that most states do not. Illinois imposes its own estate tax with an exclusion amount far below the federal level — long set at $4 million and not indexed for inflation, though as of 2026 you should confirm the current Illinois exclusion and any legislative change with the Illinois Attorney General’s office, which administers the tax. The practical consequence: an Illinois family can be comfortably clear of federal exposure and squarely inside Illinois exposure. Do not let the national headline about federal exemptions drive a decision to unwind coverage for a client whose taxable estate sits between the Illinois threshold and the federal one. The Illinois estate tax analysis has to be run first.
The Trustee’s Options When the Premium Stops
Once gifting slows, the realistic menu for the trustee is short: keep paying from trust assets if any exist, reduce the face amount, elect reduced paid-up coverage, exchange into a lower-cost product, surrender for cash surrender value, or test the secondary market. In most administrations the last option is the one nobody prices, which is exactly why it is worth pricing — surrender pays cash surrender value only, and market pricing has historically run several multiples of that for qualifying policies.
For the drafting attorney the relevant point is authority. Does the trust instrument grant the trustee power to sell trust property generally and insurance specifically? Does it require beneficiary notice or consent? Is there a trust protector who can be involved? Under the Illinois Trust Code the trustee’s duties of prudence, loyalty, and information-sharing apply to a life insurance policy the same way they apply to any other trust asset, and the defensible record is a documented review with a written rationale — not an unexamined lapse.
Tax Mechanics You Should Know Before the Client’s CPA Asks
The federal framework for a policy sale by the owner runs in two tiers. Gain up to the excess of cash surrender value over basis is generally ordinary income; gain above that amount is generally capital gain. Basis is generally total premiums paid — Revenue Ruling 2020-05 conformed IRS guidance to the 2017 Act’s change and eliminated the old requirement, from Revenue Ruling 2009-13, that a seller reduce basis by cost-of-insurance charges. That change materially improved seller outcomes and is worth knowing when a client asks why an older memo in the file says something different.
Separately, a sale is a reportable policy sale under IRC Section 6050Y. The buyer, the issuing carrier, and the seller are all inside the reporting regime, and your client should expect Forms 1099-LS and 1099-SB to arrive. Tell them in advance so the forms are not a surprise to a CPA who has never seen one. Illinois taxes the gain portion at its flat individual income tax rate as part of federal adjusted gross income; see our overview of life settlement taxes in Illinois, and route the actual computation to the client’s tax advisor.
| Disposition | Typical Proceeds | Tax Treatment (Federal, General) | Drafting / Administration Note |
|---|---|---|---|
| Lapse | None | Possible phantom income if a loan is outstanding | Hardest outcome to defend in a trustee review |
| Surrender | Cash surrender value | Ordinary income on gain above basis | Simple, but forfeits any market premium |
| Reduced paid-up | No cash; smaller death benefit | Generally none at election | Preserves legacy, produces no liquidity |
| 1035 exchange | No cash; new contract | Generally tax-deferred | Useful when some coverage is still wanted |
| Market sale | Historically ~10-35% of face (GAO-10-775) | Ordinary income to CSV over basis; capital gain above; 6050Y reporting applies | Confirm trustee’s power to sell and any notice/consent requirement |
| Transfer to family member | Whatever is paid | Transfer-for-value exposure under IRC 101(a)(2); IRC 2035 three-year rule if by the insured | Sequence the analysis before the transfer, not after |
Transfer-for-Value and the Three-Year Rule
Two traps worth flagging in any memo you write on this subject. First, the transfer-for-value rule of IRC Section 101(a)(2) can convert an otherwise tax-free death benefit into taxable income in the hands of a transferee, subject to exceptions. It matters less in an outright market sale by the owner than in the intra-family or entity transfers clients sometimes propose as a cheaper alternative — those are where the rule bites.
Second, IRC Section 2035 pulls a policy transferred by the insured within three years of death back into the gross estate. That is the reason a client who is considering both a policy sale and a transfer to an existing trust needs the sequence analyzed rather than improvised. Neither of these is a reason to avoid the market; both are reasons the decision belongs with counsel rather than with a salesperson.
Fitting Proceeds Back Into the Plan
The money does not have to leave the structure. Depending on the instrument, proceeds from a trust-owned policy stay in the trust and get redeployed — into a smaller, fully funded guaranteed universal life policy where some coverage is still wanted, into a diversified portfolio, or into distributions consistent with the trust purpose. For individually owned policies the proceeds are often the cleanest available funding source for long-term care that the client would otherwise pay for by liquidating appreciated securities and triggering gain.
Where an Illinois client is on a path toward long-term care Medicaid, the interaction is worth understanding in advance rather than after the check clears. Illinois runs long-term care coverage through HealthChoice Illinois managed long term services and supports and the Community Care Program, with an individual countable-asset limit raised to $17,500 in 2023 — one of the most generous in the country, and a figure to confirm for 2026 with the Illinois Department of Healthcare and Family Services. Our summary of Illinois Medicaid asset and income limits lays out the framework.
How a Referral Works
Deliberately minimal on your end. With the client’s permission, send a redacted policy cover page — carrier, policy type, face amount, issue date, insured’s date of birth. That is enough for a free read on whether the policy is a realistic candidate, typically back to you in one to two business days. No client contact unless your client asks for it, and no obligation for you or the client.
If the client wants an indicative range, four documents do it: cover page, current in-force illustration, latest carrier statement, and a signed HIPAA authorization. The profile that fits the market is an insured roughly 70 or older, or any age with a material health change since issue; a death benefit of $100,000 or more; and a permanent, guaranteed universal life, whole life, or convertible term policy. A completed file typically runs about 60 to 120 days through underwriting to funding, with money held in independent escrow and ownership transferring only after payment is confirmed. Market-wide, sellers have historically received on the order of 10% to 35% of face value, averaging roughly 4 to 8 times surrender value in the federal Government Accountability Office’s study of the market (GAO-10-775). No one can name a specific number without the file.
Call (305) 209-7183, or start with our comparison of a life settlement versus surrender.
Compliance Note for the File
Illinois settlements are governed by the Illinois Viatical Settlements Act, 215 ILCS 158, with the Illinois Department of Insurance as regulator for licensing, disclosure, and complaints. Verify any counterparty’s standing with the Department directly. Pine Lake does not pay referral compensation to attorneys, and this page is educational only — it is not an offer to purchase any policy, and it is not legal, tax, or investment advice to you or your client. Independent counsel and the client’s own tax advisor should review any proposed transaction before it closes.
Frequently Asked Questions
Which trust-owned policies are most likely to be settlement candidates?
Policies inside ILITs created to fund a federal estate tax the family is no longer projected to owe, especially where the grantor has slowed or stopped annual exclusion gifting. Add an insured around 70 or older, a face amount of $100,000 or more, and a permanent or convertible policy type, and you have the standard profile. Illinois practitioners should check the separate Illinois estate tax exposure before concluding the coverage is unnecessary.
Does the Illinois estate tax change the analysis?
Often yes. Illinois imposes its own estate tax with an exclusion amount well below the federal level, historically $4 million and not indexed for inflation; as of 2026, confirm the current figure and any legislative change with the Illinois Attorney General’s office, which administers the tax. A family clear of federal exposure can still face an Illinois liability, and the coverage may still be doing real work.
How is basis calculated on a policy sale now?
Under Revenue Ruling 2020-05, which conformed IRS guidance to the 2017 Tax Cuts and Jobs Act, the seller’s basis is generally total premiums paid and is no longer reduced by cost-of-insurance charges as Revenue Ruling 2009-13 had required. That is a meaningful improvement over the older treatment. The client’s CPA should run the actual computation.
What is IRC Section 6050Y and will my client get forms?
Section 6050Y is the reportable policy sale information reporting regime. The buyer, the issuing carrier, and the seller are all inside it, and your client should expect Forms 1099-LS and 1099-SB after a sale closes. Warn them in advance so the forms reach the tax preparer rather than a drawer.
Can a trustee sell a policy without beneficiary consent?
It depends entirely on the trust instrument and on the notice and consent provisions that apply under the Illinois Trust Code. Many instruments grant a general power to sell trust property that reaches insurance; some require notice to qualified beneficiaries. Read the document before advising, and document the review and rationale either way.
Does selling a policy trigger the three-year rule?
IRC Section 2035 pulls a policy transferred by the insured within three years of death back into the gross estate, which is why the sequencing of any sale or transfer matters when the client’s health is a factor. A market sale by a trust that has owned the policy for years presents differently from a client transferring a policy into a trust today. Analyze the sequence before acting.
What do you need from me to give the client an answer?
One redacted cover page, sent with the client’s permission — carrier, policy type, face amount, issue date, insured’s date of birth. That is enough for a free candidate assessment in one to two business days at no cost and no obligation. If the client wants a range, add the in-force illustration, the latest carrier statement, and a signed HIPAA authorization.
Do you pay referral fees to attorneys?
No. Pine Lake does not pay referral compensation to attorneys, and an offer of referral fees from any participant in this market is a reason to look more carefully at that participant. The clean posture for an estate planning practice is information and referral with no financial interest in the outcome, disclosed in writing to the client.
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Related Reading
- Life Settlement Vs Surrender
- Cash Surrender Value Life Insurance
- How It Works Policy Options
- Life Settlement Taxes Illinois
- Illinois Medicaid Asset Income Limits
Pine Lake Life Solutions does not purchase life insurance policies and does not provide legal, tax, or investment advice. Information provided is for educational purposes only. Eligibility for any option, including life settlements, is not guaranteed and depends on individual circumstances, policy terms, underwriting, and market conditions. Consult independent legal, tax, or financial professionals before making decisions regarding a life insurance policy.