July 2, 2026
9:58 pm

Is Your ILIT Obsolete? Trust-Owned Policies in the Post-TCJA World

An irrevocable life insurance trust is not automatically obsolete after the Tax Cuts and Jobs Act, but for a large share of families the estate-tax problem the ILIT was built to solve no longer exists. With the federal estate tax exemption now above $13 million per individual — more than $26 million for a married couple — many trust-owned policies purchased to pay a tax bill that will never arrive are still consuming annual premium gifts. That mismatch creates real decisions for grantors and real fiduciary exposure for trustees, because an unneeded policy can be kept, restructured, surrendered, distributed, or sold, and each path has very different economics.

This article walks through why ILITs were created, what the TCJA changed, how to recognize a trust that has outlived its purpose, what an ILIT still does well, and the full menu of options — including how a life settlement works when the seller is a trust.

In This Article

The Job Your ILIT Was Hired to Do
What the TCJA Changed — and What 2025 Made Permanent
Six Signs an ILIT May Have Outlived Its Purpose
What an ILIT Still Does Well
The Trustee’s Problem: Fiduciary Duty Survives the Tax Rationale
The Exit Menu for an Unneeded Trust-Owned Policy
How a Life Settlement Works When a Trust Is the Seller
How Sale Proceeds Are Taxed Inside the Trust
A Review Framework Before Deciding Anything
Frequently Asked Questions

Is Your ILIT Obsolete? Trust-Owned Policies in the Post-TCJA World

The Job Your ILIT Was Hired to Do

To judge whether an ILIT is obsolete, start with why it exists. Life insurance death benefits are generally free of income tax, but they are not free of estate tax if the insured owns the policy at death. For decades, that was a serious problem, because the federal estate tax reached far below the ultra-wealthy: the exemption was $600,000 through most of the 1990s and still only $5.49 million per person as recently as 2017. A successful business owner with a $2 million policy could watch a large slice of the death benefit disappear to a tax rate that has reached as high as 40%.

The irrevocable life insurance trust was the standard fix. The grantor creates an irrevocable trust, the trust owns the policy from inception (or receives an existing policy and survives the three-year lookback rule), and the trust is named beneficiary. Because the insured holds no incidents of ownership, the death benefit lands outside the taxable estate. Each year the grantor gifts premium money to the trust, and beneficiaries receive short-term Crummey withdrawal rights so those gifts qualify for the annual gift tax exclusion.

It is an elegant machine — but notice that every gear turns around one assumption: that the estate will owe federal estate tax. When that assumption fails, the machine keeps running, keeps consuming premium gifts, and keeps imposing administrative work, while the benefit it was engineered to deliver quietly evaporates.

What the TCJA Changed — and What 2025 Made Permanent

The Tax Cuts and Jobs Act of 2017 roughly doubled the federal estate, gift, and generation-skipping transfer tax exemptions beginning in 2018. Indexed for inflation, the exemption climbed above $13 million per individual, and with portability a surviving spouse can generally use a deceased spouse’s unused exemption, pushing a married couple’s combined shelter past $26 million. The practical result: only a very small fraction of American estates now owe any federal estate tax at all.

For years, planners hedged because the TCJA’s doubled exemption was scheduled to sunset after 2025. That cliff never arrived — tax legislation enacted in 2025 made the elevated exemption permanent and set it at $15 million per person beginning in 2026, indexed going forward. The IRS publishes the current figures annually, and our companion piece on the federal estate tax exemption tracks the numbers in detail.

Consider what this means for a typical ILIT drafted in 2004. A couple with a $9 million estate bought a $3 million survivorship policy inside a trust to cover a projected estate tax bill. Under the exemptions in force when the trust was drafted, that bill was real. Under today’s exemptions, the same couple owes nothing federally — yet the trust may still be paying (or straining to pay) five-figure annual premiums for liquidity nobody needs. Multiply that scenario across the hundreds of thousands of ILITs created in the 1990s and 2000s, and you have one of the most common — and least discussed — legacy problems in American estate planning.

Six Signs an ILIT May Have Outlived Its Purpose

Obsolescence is a fact question, not a feeling. These are the markers that most often signal a trust-owned policy no longer earns its keep:

The estate sits far below the exemptions. If the combined estate — including the death benefit the trust would collect — is comfortably under the federal threshold and any applicable state threshold, the core tax rationale is gone.
The policy was purchased purely for estate liquidity. Coverage bought to pay a tax bill, rather than to replace income or fund a specific bequest, loses its mission when the bill disappears.
Premium gifts have become a burden. Grantors in their 80s funding steep universal life premiums out of retirement cash flow are effectively paying for protection nobody will use.
The policy itself is deteriorating. Older universal life contracts built on high interest-crediting assumptions frequently need much larger premiums than illustrated, or face lapse even with continued funding.
Beneficiaries would rather have value now. Adult children who understand the numbers often prefer a smaller certain amount today over a distant death benefit financed by their parents’ savings.
No state-level exposure exists. If the family lives in a state without its own estate or inheritance tax, the last tax argument for the structure may fall away.

One or two of these signs justify a review. Four or more usually justify action — though, as the next section shows, action does not always mean exit.

What an ILIT Still Does Well

Honest analysis cuts both ways: “obsolete for federal estate tax” is not the same as “useless.” Before any irreversible step, grantors and trustees should credit the jobs an ILIT still performs:

Creditor and divorce protection. Assets in a properly drafted irrevocable trust with spendthrift provisions are generally beyond the reach of beneficiaries’ creditors and divorcing spouses — protection an outright inheritance never has.
State estate and inheritance taxes. A minority of states levy their own death taxes with thresholds far below the federal exemption. For residents of those states, the ILIT may still be doing exactly what it was designed to do.
Control over timing and behavior. Trust terms can stage distributions, protect beneficiaries with special needs or spending problems, and manage blended-family dynamics in ways a beneficiary designation cannot.
Liquidity for illiquid estates. Families whose wealth sits in a business, farm, or real estate may still need cash at death to equalize inheritances or fund buyouts, even if no tax is due.
A hedge against future law. Exemptions that rose by legislation can fall by legislation. An existing, seasoned trust with an in-force policy is difficult to recreate later at older ages and worse health.

The right question is never “are ILITs obsolete?” in the abstract. It is whether this trust, holding this policy, for this family, still delivers benefits that justify its ongoing cost.

Option for a Trust-Owned Policy	What the Trust Receives	Death Benefit Outcome	Typical Timing	Key Considerations
Keep and continue funding	Nothing now; death benefit later	Preserved in full	Ongoing	Best when non-tax purposes remain and premiums are sustainable
Reduced paid-up conversion	No cash; premium gifts stop	Preserved at a smaller amount	Days to weeks	Whole life only; keeps permanent coverage without further funding
1035 exchange	A replacement contract, tax-free	Depends on new contract	Weeks	Useful when coverage is still wanted but the current policy fits poorly
Distribute policy to beneficiaries	Asset leaves the trust	Shifted to new owners	Weeks; requires trust authority	Moves the decision to beneficiaries; legal review essential
Surrender to carrier	Cash surrender value only	Lost	Days to weeks	Often the lowest value for policies that would attract offers
Life settlement	Typically 10-35% of face value (roughly 4-8x surrender value)	Lost; buyer collects it	60-120 days	Insured generally 65+, policy $100,000+; taxable; rescission window 15-30 days by state
Let the policy lapse	$0	Lost	Automatic after 30-31 day grace period	The outcome fiduciary review exists to prevent

The Trustee’s Problem: Fiduciary Duty Survives the Tax Rationale

Here is the uncomfortable part for anyone serving as an ILIT trustee — often a family member or family advisor who accepted the role assuming it meant little more than mailing Crummey notices. The trustee’s fiduciary duties do not shrink because the tax law changed. A trustee must administer the trust prudently, which courts and commentators increasingly read to include monitoring the trust’s primary asset: the policy itself.

That means ordering in-force illustrations periodically, verifying the policy is not drifting toward lapse, evaluating whether the carrier remains sound, and — critically — assessing whether continuing to hold the policy still serves the beneficiaries. A trustee who lets a funded policy quietly lapse, or who surrenders a policy for a fraction of what the secondary market would have paid, invites the question every fiduciary dreads: what did you do to determine the asset’s value before disposing of it? Our guide to ILIT trustee duties covers the full checklist.

The reverse error is just as real. Trustees who keep collecting premium gifts for a policy nobody needs, without documenting why, are not being cautious — they are being passive. Prudence is a process: restate the trust’s purpose, gather current policy data, price the alternatives, take advice where needed, and write down the reasoning. A trustee with a documented file is well protected whichever way the decision goes; a trustee with no file is exposed either way.

When review concludes that the policy no longer fits, the trustee typically has more options than most families realize:

Keep, but restructure the funding. Reduce the face amount to cut premiums, or shift a flexible-premium policy to a sustainable funding level.
Reduced paid-up insurance. Whole life contracts can often be converted so premiums stop entirely in exchange for a smaller permanent death benefit — no cash out, but no further gifts required.
1035 exchange. The trust can exchange the policy tax-free for a contract that better fits current goals, such as one with long-term care benefits or lower carrying costs.
Distribute the policy to beneficiaries. Where the trust instrument permits, the policy can sometimes be distributed out, shifting the keep-or-exit decision to the people who ultimately own the outcome.
Surrender to the carrier. Fast and simple, but the trust receives only the cash surrender value — often the lowest number on the table for a policy that would attract settlement offers.
Lapse. Walking away surrenders all value and is the outcome fiduciary review exists to prevent.
Life settlement. Selling the policy to a licensed institutional buyer, typically for several times the surrender value when the insured qualifies.

The surrender-versus-sale comparison deserves particular care, because the spread between the two numbers can be enormous; we analyze it in depth in ILIT surrender vs. settlement.

How a Life Settlement Works When a Trust Is the Seller

A trust can sell a policy it owns just as an individual can — the trustee simply signs the transaction documents in a fiduciary capacity. The eligibility profile is the same: the insured is generally 65 or older (younger with significant health impairments), the face amount is generally $100,000 or more, the policy has been in force at least two years, and the contract is permanent — universal life, whole life, or survivorship — or convertible term. Many legacy ILIT policies fit this profile precisely, because they were bought on insureds who are now in their late 70s and 80s.

The process runs 60 to 120 days. The trustee provides policy and medical authorizations, buyers order two independent life expectancy reports (which take two to six weeks), licensed providers bid, and closing funds move through escrow before ownership changes hands. When offers are made, they typically fall between 10% and 35% of face value — roughly four to eight times the cash surrender value, according to the U.S. Government Accountability Office’s market study (GAO-10-775). Transactions are regulated at the state level under frameworks based on the NAIC Life Settlements Model Act, with licensing, disclosure, and rescission protections.

For a trustee, the appraisal value of this market is worth stressing: even a trustee who ultimately keeps or surrenders the policy strengthens the fiduciary record by learning what institutional buyers would pay. Our companion article on life settlements for trustees covers documentation, beneficiary communication, and process safeguards in detail.

How Sale Proceeds Are Taxed Inside the Trust

Selling a trust-owned policy is a taxable event, and the framework is the same three-tier treatment that applies to individual sellers under IRS Revenue Ruling 2009-13, as modified by the TCJA. Proceeds up to the investment in the contract — roughly, cumulative premiums paid — return tax-free as basis. The slice between basis and the policy’s cash surrender value is ordinary income. Anything above the surrender value is capital gain. Helpfully, the TCJA confirmed that sellers no longer reduce basis by the cost-of-insurance charges, which had been a punitive quirk of the original ruling.

Who pays the tax depends on the trust’s income tax status. Many ILITs are grantor trusts, meaning the grantor reports the trust’s income personally at individual rates. A non-grantor trust reports the income itself, and trust tax brackets compress quickly — trusts reach the top federal rate at very low income levels — so the character of the gain and the possibility of distributing income to beneficiaries in lower brackets both matter. Viatical rules offer a separate carve-out: where the insured is terminally ill with a life expectancy under 24 months, proceeds are often income-tax-free under IRC Section 101(g).

None of this should be modeled on the back of an envelope. Basis records for decades-old policies can be incomplete, and the grantor/non-grantor distinction changes the answer materially. A tax professional should run the numbers before the trustee signs anything; the general mechanics are laid out in the resources published by the IRS and in professional tax guidance.

A Review Framework Before Deciding Anything

Whether you are the grantor who funds the trust or the trustee who administers it, the same disciplined sequence produces a defensible decision:

Step 1 — Restate the purpose. Pull the trust instrument and write one sentence describing why the policy was bought. Estate liquidity? Income replacement? Equalization? The original purpose is the benchmark everything else is measured against.
Step 2 — Run the estate projection. Model the combined estate against current federal and state thresholds, including the death benefit. Involve the drafting attorney or a successor.
Step 3 — Order in-force illustrations. Request projections at current funding, minimum funding, and zero funding. Many “healthy” policies are quietly on a path to lapse.
Step 4 — Price every alternative. Get the surrender value, the reduced paid-up quote, the 1035 options, and — where the insured’s age and policy size qualify — a read on secondary-market value.
Step 5 — Weigh the non-tax benefits. Creditor protection, state taxes, control, and the option value of keeping coverage all belong in the file.
Step 6 — Document and decide. Record the analysis, the advice received, and the reasoning, then act.

Two cautions apply throughout. A sale or surrender is irreversible once any rescission window closes, and no outcome — offer amounts included — is ever guaranteed. But the worst result is the one produced by inertia: years of premium gifts flowing into a trust whose purpose expired quietly in 2018.

Frequently Asked Questions

Is an ILIT still worth keeping now that the estate tax exemption is so high?

Sometimes yes, often no — it depends on what the trust still does for the family. If the estate sits far below federal and state thresholds and the policy exists only to pay a tax that will never be due, the structure may be pure cost. But ILITs also provide creditor and divorce protection, shelter against state-level death taxes, distribution control for beneficiaries, and liquidity for illiquid estates like businesses and real estate. The disciplined approach is to restate the trust’s purpose, project the estate against current exemptions, and let the facts — not inertia — decide.

Can an irrevocable life insurance trust be unwound or terminated?

Irrevocable does not always mean untouchable, but termination requires legal work. Depending on state law and the trust instrument, options can include distributing the policy to beneficiaries, decanting to a trust with better terms, nonjudicial settlement agreements among the parties, or court modification when the trust’s purpose has become impossible or impractical. Simply stopping premium gifts is not termination — it usually just sets the policy on a path to lapse. An estate planning attorney should map the available routes before any asset inside the trust is surrendered or sold.

Can the trustee of an ILIT sell the life insurance policy in a life settlement?

Generally yes, provided the trust instrument and state law give the trustee power to sell trust assets — a standard power in most modern documents. The trustee signs the settlement paperwork in a fiduciary capacity, the trust receives the lump sum, and the proceeds are then held or distributed under the trust’s terms. Eligibility mirrors individual sales: insureds generally 65 or older, policies generally $100,000 or more, in force at least two years. Prudent trustees document why a sale serves beneficiaries better than keeping, surrendering, or restructuring the policy.

What happens if the grantor just stops gifting premiums to the ILIT?

The policy starts consuming itself. A universal life contract will draw remaining cash value to cover monthly charges until the value runs out, after which the policy enters a 30-31 day grace period and lapses, and the trust receives nothing. A whole life policy may limp along on dividends or automatic premium loans, shrinking its value. Stopping gifts without a plan is the most expensive form of exit because it forfeits both the death benefit and the cash the trust could have received through surrender or a settlement while the policy was still in force.

How is a life settlement taxed when the policy is owned by a trust?

The same three-tier framework from IRS Revenue Ruling 2009-13 applies: proceeds up to cumulative premiums paid return tax-free as basis, the amount between basis and cash surrender value is ordinary income, and the excess above surrender value is capital gain. The difference is who pays. If the ILIT is a grantor trust, the grantor reports the income personally. If it is a non-grantor trust, the trust pays at compressed trust brackets unless income is distributed to beneficiaries. Because old policies often have murky basis records, a tax professional should run the numbers first.

Can a trustee be held liable for letting an ILIT policy lapse?

It is a genuine risk. Trustees owe beneficiaries a duty of prudent administration, which increasingly includes monitoring trust-owned insurance — ordering in-force illustrations, watching for underperformance, and evaluating alternatives before a policy dies of neglect. A trustee who allows a marketable policy to lapse, or surrenders it without checking what licensed buyers would have paid, can face claims for the value beneficiaries lost. The best protection is a documented process: regular policy reviews, professional advice where warranted, and a written record of why each decision was made.

Should the ILIT distribute the policy to beneficiaries instead of selling it?

Distribution can make sense when beneficiaries want the coverage and are willing to fund it themselves — for instance, adult children who prefer to keep a parent’s policy in force as an investment in the eventual death benefit. It requires authority in the trust instrument, may have gift and income tax wrinkles, and removes the asset from the trust’s creditor protection. If beneficiaries would simply surrender or abandon the policy after receiving it, a trustee-managed sale usually produces more value. The choice deserves side-by-side numbers and legal review, not a default.

How much could an ILIT receive for selling its policy?

When offers are made, they typically fall between 10% and 35% of the policy’s face value, which the GAO found works out to roughly four to eight times cash surrender value. A $1 million trust-owned universal life policy on an 82-year-old, for example, might draw offers between $100,000 and $350,000 depending on health, premium load, and policy structure — while some policies draw no offers at all. Every case is individually underwritten with two independent life expectancy reports, so the only reliable answer comes from actually testing the market through licensed channels.

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