For estate planning attorneys in California, the post-TCJA question is unavoidable: what should be done with trust-owned life insurance bought to pay an estate tax the client no longer owes? With the federal estate exemption above $13 million per individual, many ILIT policies have outlived their purpose — and a policy the trust would otherwise surrender or lapse may sell in the regulated secondary market for 4–8× its cash surrender value.
This page covers ILIT dispositions, trustee fiduciary documentation, and how California regulates the transaction.
In This Article
- The Post-TCJA Problem: Trusts That Outlived Their Purpose
- Trustee Fiduciary Duty: Valuation Before Disposition
- How California Regulates the Sale of a Trust-Owned Policy
- ILIT Mechanics: Who Signs, Who Receives, What the Documents Must Support
- Tax Treatment of the Trust’s Sale
- Where an Educational Firm Fits in the Attorney’s Workflow
- Frequently Asked Questions
The Post-TCJA Problem: Trusts That Outlived Their Purpose
A generation of irrevocable life insurance trusts was funded to create estate-tax liquidity when the exemption was a fraction of today’s figure. With the federal exemption now above $13 million per individual, a large share of those trusts no longer serve their original purpose — yet the policies inside them keep consuming Crummey gifts, and universal life contracts written in earlier interest-rate environments often demand rising premiums to stay in force. The default outcomes — lapse, or surrender for the carrier’s cash value — are frequently the worst-priced dispositions available.
A trust-owned policy is trust property, and since Grigsby v. Russell (1911) a life insurance policy has been freely assignable personal property. Where the insured fits the settlement profile — generally 65+, face value $100,000+, policy in force 2+ years — the trustee’s disposal analysis should include a secondary-market valuation alongside surrender. The GAO’s report on the market (GAO-10-775) documents settlements paying multiples of surrender value.
Trustee Fiduciary Duty: Valuation Before Disposition
A trustee who surrenders or lapses a marketable policy without checking its market value has disposed of trust property below its obtainable price — precisely the kind of decision beneficiaries later question. The prudent-administration posture is straightforward:
- Obtain an in-force illustration showing current values and the premium stream required to maintain coverage
- Price every alternative — continue funding, reduce the face amount, elect reduced paid-up status, surrender, or sell
- Obtain a secondary-market valuation — free, non-binding, and the only way to know the asset’s market price
- Document the comparison and the reasoning behind the chosen disposition in the trust file
- Verify licensing of every settlement party with the state regulator before contracts are signed
Whether the trustee ultimately keeps, restructures, or sells, the file showing the analysis is the protection. Our process guide shows what the valuation stage actually involves.
How California Regulates the Sale of a Trust-Owned Policy
In California, the transaction is governed by California Insurance Code §§ 10113.1–10113.3 (life settlements), administered by the California Department of Insurance. California licenses life settlement providers through the Department of Insurance, and life settlement brokers must also be licensed; experienced licensed life agents can qualify to act as brokers by notifying the department.
The owner of record — here, the trust, acting through its trustee — is the seller, and the consumer protections run to it: mandatory written disclosures of alternatives and broker compensation, privacy handling of the insured’s medical records, anti-STOLI rules, and a rescission right (30 days after the contract is executed by all parties (with all disclosures received) or 15 days after receipt of proceeds, whichever is sooner). The framework follows the NAIC Life Settlements Model Act pattern adopted across most states.
| ILIT Policy Disposition | Trust Receives | File Documentation Value |
|---|---|---|
| Lapse | Nothing | Weakest — asset abandoned |
| Surrender | Cash surrender value | Weak unless market was checked first |
| Reduced paid-up | No cash; smaller paid-up benefit | Strong where coverage still wanted |
| Life settlement | Typically 4–8× surrender value | Strong — market price obtained and documented |
ILIT Mechanics: Who Signs, Who Receives, What the Documents Must Support
Before a trust-owned policy is marketed, confirm the plumbing:
- Authority — the trust instrument (or applicable trust code default powers) must permit the trustee to sell trust property; most modern instruments do
- Signatures — the trustee executes the settlement contract as owner; the insured signs HIPAA and carrier authorizations individually
- Proceeds — funds are paid to the trust, and their subsequent treatment (hold, distribute, reinvest) follows the trust’s terms and the trustee’s distribution analysis
- Insured cooperation — underwriting requires medical records, so the insured’s willingness to cooperate is a practical prerequisite worth confirming early
Where the trust holds a survivorship (second-to-die) policy — common in estate plans of this era — note that survivorship contracts are routinely settled, and their pricing turns on joint life expectancy.
Tax Treatment of the Trust’s Sale
The three-tier framework of IRS Revenue Ruling 2009-13, as modified by the TCJA, applies to the selling trust: proceeds up to premium basis are recovered tax-free, basis to cash surrender value is ordinary income, and the remainder is generally long-term capital gain. The TCJA also fixed the old basis-reduction trap, so basis is no longer reduced by cost-of-insurance charges. Grantor-trust status determines whose return the income lands on — a point to settle with the client’s CPA before the offer stage, not after. California has the highest state income tax rates in the country (top marginal rate of 13.3%), which can apply to taxable life settlement gains. Our tax treatment guide covers the tiers with worked examples.
Where an Educational Firm Fits in the Attorney’s Workflow
Pine Lake Life Solutions is an educational firm — not a buyer — so engaging us for a valuation creates no sale obligation and no conflict to disclose beyond the engagement itself. For California counsel, the typical workflow: a 15-minute eligibility read on the trust policy, a written summary the trustee can put in the file, and — only if the trustee elects to proceed — a brokered competitive process among licensed buyers with every offer disclosed. When the numbers favor keeping or restructuring the policy, the trustee gets that conclusion in writing instead. We work with attorneys throughout California, including Los Angeles and San Diego, by phone and video.
Frequently Asked Questions
Can an ILIT trustee sell a trust-owned life insurance policy?
Yes, if the trust instrument or applicable default powers authorize the sale of trust property — as most modern instruments do. The trustee signs as owner, the insured signs medical and carrier authorizations, and proceeds are paid to the trust. In California, the transaction must comply with California Insurance Code §§ 10113.1–10113.3 (life settlements).
Is a trustee required to get a life settlement valuation before surrendering a policy?
No statute compels it, but prudent administration points hard in that direction: a free valuation is the only way to know the market price of trust property before disposing of it, and settlements on qualifying policies typically run 4–8× surrender value. The comparison memo — whatever the outcome — is inexpensive fiduciary protection.
How is the sale of a trust-owned policy taxed in California?
Under IRS Rev. Rul. 2009-13 as modified by the TCJA: basis recovered tax-free, basis-to-surrender-value as ordinary income, the excess as long-term capital gain, with grantor-trust status determining whose return reports it. California has the highest state income tax rates in the country (top marginal rate of 13.3%), which can apply to taxable life settlement gains. Coordinate with the client’s CPA before accepting an offer.
What happens to a TCJA-obsolete ILIT after the policy is sold?
The trust holds cash instead of a policy. Depending on its terms, the trustee may distribute, hold, or reinvest the proceeds — and counsel can then evaluate whether the trust should be decanted, modified, or wound down. Selling the policy converts a premium-consuming asset into liquidity that makes the trust-level decision far easier.
Can a survivorship (second-to-die) policy inside a trust be settled?
Yes — survivorship policies are routinely sold in the secondary market, and they are common in ILITs from the era when estate-tax liquidity planning drove the purchase. Pricing turns on the joint life expectancy of both insureds and the policy’s premium load, and the same regulatory protections apply to the selling trust.
Who regulates the buyer when a California trust sells a policy?
The California Department of Insurance. California licenses life settlement providers through the Department of Insurance, and life settlement brokers must also be licensed; experienced licensed life agents can qualify to act as brokers by notifying the department. Verify the authorization of every provider and broker in the transaction directly with the regulator at https://www.insurance.ca.gov before the trustee signs — a legitimate party will expect the check.
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Related Reading
- Life Settlements California
- Life Settlement Regulation California
- Life Settlement Tax Treatment Guide
- What Is A Life Settlement
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.