Life insurance is one of the most common tools people use to protect their families after they are gone. But many California families are surprised to learn that life insurance proceeds can be counted as part of a taxable estate, potentially reducing what their loved ones actually receive. An irrevocable life insurance trust, commonly called an ILIT, is a planning strategy designed to change that.
If you are wondering how an irrevocable life insurance trust minimizes estate taxes while keeping your beneficiaries protected, this guide walks through exactly how these trusts work under California and federal law.
What Is an Irrevocable Life Insurance Trust?
An ILIT is a trust that owns a life insurance policy and is structured to generally remove the death benefit from your taxable estate, provided certain IRS requirements are met. This can allow beneficiaries to receive the full insurance proceeds in many cases.
An ILIT is a separate legal entity that holds ownership of a life insurance policy. Because the trust, rather than you, owns the policy, the death benefit is generally not included in your gross estate for federal estate tax purposes if the trust is properly structured and administered. That distinction matters more than most people realize.
Under the Internal Revenue Code, if you hold any “incidents of ownership” over a life insurance policy at the time of your death, the full death benefit gets included in your taxable estate. Incidents of ownership include the ability to change beneficiaries, borrow against the policy, or surrender it. By transferring the policy to an ILIT and giving up those rights, you can generally exclude the proceeds from your taxable estate, assuming no retained incidents of ownership and compliance with IRS rules.
How Does an ILIT Reduce Federal Estate Taxes?
When a life insurance policy is owned by an ILIT, its death benefit is typically excluded from your gross estate, which may reduce the amount subject to federal estate tax when properly structured.
For 2025, the federal estate tax exemption is $13.99 million per individual, as set by the IRS. Married couples may combine exemptions through portability if properly elected on a timely filed estate tax return, potentially sheltering nearly $28 million. But that exemption is scheduled to drop significantly after December 31, 2025, when the Tax Cuts and Jobs Act provisions are set to expire. Without new legislation, the exemption could return to roughly $7 million (adjusted for inflation).
For estates in Bakersfield or anywhere in California that exceed the applicable exemption threshold, life insurance proceeds sitting inside the estate can push the taxable value higher. A properly structured ILIT can generally keep those proceeds out of that calculation.
California does not impose a separate state estate tax, so the primary concern is federal exposure. Still, for high-net-worth families, even a modest reduction in the taxable estate can preserve hundreds of thousands of dollars for the next generation.
How Are Beneficiaries Protected Through an ILIT?
An ILIT protects beneficiaries by controlling how and when proceeds are distributed, shielding funds from creditors, and reducing the risk of mismanagement.
Removing proceeds from your estate is only part of the picture. An ILIT also gives you significant control over how the money reaches your loved ones. As the grantor, you work with an attorney to draft the trust document, which includes distribution instructions. You can specify that funds be used for education, housing, or health care. You can stagger distributions by age. You can include protections for beneficiaries who may struggle with debt, divorce, or financial management.
This structure is particularly valuable for families with minor children or beneficiaries who may need guidance in managing a large sum of money. The trustee, who is someone other than you, oversees the distributions in accordance with your instructions.
Because the trust is a separate legal entity, it may provide a layer of protection from your beneficiaries’ creditors, depending on how it is drafted and applicable state law. That layer of protection is something a straightforward beneficiary designation on a policy cannot offer.
What Are the Key Requirements for an ILIT to Work?
For an ILIT to accomplish its estate planning goals, several rules must be followed carefully.
- You generally should not serve as the trustee. Retaining control over the trust can cause the IRS to pull the proceeds back into your estate.
- The Crummey notice requirement must be met. When you make premium payments by gifting money to the trust, beneficiaries must receive written notice of their right to withdraw those funds for a limited period, typically a 30-day withdrawal period, depending on the terms of the trust. This satisfies the IRS requirements for the annual gift tax exclusion under IRC Section 2503(b), currently $19,000 per recipient (2025, indexed annually for inflation and subject to change).
- The three-year rule applies to transferred policies. If you transfer an existing policy to an ILIT and die within three years of the transfer, the proceeds are still included in your estate under IRC Section 2035. The cleaner approach is to have the trust purchase a new policy from the start.
- The trust must be irrevocable. Once it is established, you cannot take it back or change its terms without the consent of the beneficiaries.
Is an ILIT Right for Your Estate Plan?
An ILIT is not a fit for every situation. It works best when the estate is likely to exceed the federal exemption threshold, when significant life insurance coverage is in place, or when protecting the eventual payout from creditors and mismanagement is a priority.
For families in Bakersfield and the Eastern Sierra region around Mammoth Lakes, local real estate values and business interests can push an estate into territory where this kind of planning becomes genuinely important. Starting the conversation early gives you the most options.
Talk to Our Estate Planning Team
At the Law Offices of Robert H. Brumfield, P.C., we understand that estate planning can feel overwhelming, especially when you are encountering terms like ILITs or gift tax exclusions for the first time. Our approach is straightforward: we take the time to explain what you actually need, in plain terms, and help you build a plan that reflects your goals and protects the people who matter most to you.
If you have questions about whether an irrevocable life insurance trust belongs in your estate plan, we are here to help. Contact us today or call our Bakersfield office at 661-384-6940 to schedule a consultation.
