Irrevocable Life Insurance Trusts (ILITs) in Texas: When Estate Planning Meets Insurance

What problem does an ILIT actually solve?

Life insurance death benefits are income-tax-free to the beneficiary — but they are included in the insured's federal taxable estate if the insured held any 'incidents of ownership' at death (IRC §2042). For a Texan whose combined estate — real estate, retirement accounts, business interests, life insurance — exceeds the federal exemption, that inclusion can trigger a 40% federal estate tax on the amount above the exemption.

An ILIT sidesteps this. The trust — not the insured — owns the policy and is named beneficiary. The insured has no incidents of ownership, so the death benefit is excluded from the estate. Texas has no state estate tax, so the concern is federal only.

The three-year lookback rule

Under IRC §2035, if an existing policy is transferred to an ILIT and the insured dies within three years, the death benefit is pulled back into the taxable estate. This means the cleanest structure is for the ILIT to be created first, then to apply for and own a new policy from day one — never touched by the insured.

For Texans who already own significant coverage, weigh the cost of transferring existing policies (three-year risk, gift tax reporting) against the cost of underwriting new policies inside the trust. Older insureds with impaired underwriting may be forced to transfer existing policies and simply carry the three-year risk.

Crummey letters and gift tax mechanics

The insured funds the premium each year by making a gift to the ILIT. The trustee then sends 'Crummey notices' to trust beneficiaries giving them a temporary right (typically 30 days) to withdraw the gift. This right qualifies the gift as a present-interest gift eligible for the annual federal gift tax exclusion ($19,000 per beneficiary in 2025, adjusted annually).

Skipping Crummey notices is one of the most common ILIT failures on IRS audit. The beneficiary right must be real, notice must be documented, and beneficiaries must have a genuine opportunity to withdraw. A Texas estate planning attorney should draft and administer the notice schedule.

When is an ILIT worth it in Texas?

Sweet spot: taxable estate at or above the federal exemption, a permanent life insurance need (business succession, estate liquidity, second-to-die coverage for estate tax at the second spouse's death), and enough runway on health/insurability to underwrite new coverage inside a trust.

Not worth it: estates well below the exemption (a $2M Texas estate faces zero federal estate tax and gets full step-up in basis on death — the ILIT adds cost and complexity for no tax benefit). Also not worth it if the insured needs future access to the policy's cash value — an ILIT is irrevocable and the insured cannot borrow from the policy without unwinding the estate benefit.

How to set one up in Texas

Step 1: Texas estate planning attorney drafts the trust. Cost typically $2,500–$5,000. Trustee should be a non-insured (spouse, adult child, corporate trustee). Step 2: trust obtains its own EIN from the IRS. Step 3: trustee applies for the life insurance policy — the trust is applicant, owner, and beneficiary from day one. Insured is only the measuring life.

Step 4: Insured makes annual gifts to the trust to cover premium. Trustee issues Crummey notices, then pays the carrier. File Form 709 gift tax return if annual gifts exceed the exclusion per beneficiary. Review the arrangement every 3–5 years — estate exemption changes, business valuations, and health events can all shift the calculus. For business-owner readers, our business owner strategies post covers how ILITs interact with buy-sell agreements.

Running the trust after year one

Most ILIT failures are administrative rather than structural. The annual cycle is short but unforgiving: the grantor writes a check to the trust's own bank account, the trustee deposits it, the trustee sends dated Crummey notices to each beneficiary, the withdrawal window runs its course, and only then does the trustee pay the carrier from the trust account.

Two shortcuts undo the plan. Paying the carrier directly from the grantor's personal account can be characterized as the grantor retaining control, and skipping the Crummey notice converts the gift to a future interest that does not qualify for the annual exclusion. Keep copies of every notice and every bank statement in the trust file.

The trustee should also confirm annually that the carrier has the trust — not an individual — recorded as owner and beneficiary, with the correct trust name and date. Carrier record errors on this point are common and are usually discovered at the worst possible time.

Texas-specific drafting and administration notes

Texas is a community property state, so the source of the premium dollars matters. Premiums paid with community funds can give the non-insured spouse a community interest that complicates the estate exclusion. Many Texas practitioners address this with a written partition agreement converting the funding dollars to the insured's separate property before the gifts begin.

Trustee selection also deserves Texas-specific thought. A Texas trustee keeps administration under the Texas Trust Code and avoids the question of another state's trust income tax — although with no Texas income tax, the more common issue is simply finding a trustee who will actually send the Crummey notices every year. An adult child who forgets is a worse choice than a modest corporate trustee.

Finally, coordinate the ILIT with the rest of the estate plan. The trust document should say what happens if the insured outlives the policy term, if the trust is over- or under-funded, and how proceeds interact with a marital trust or a business succession plan. A Texas board-certified estate planning attorney should review the whole structure every three to five years.