Structuring Financing with ILITs and Other Trusts to Preserve Estate Tax Benefits

Estate planning for high-net-worth (HNW) individuals in the United States increasingly relies on sophisticated life insurance structures combined with premium financing to preserve estate tax benefits while maximizing liquidity for heirs. This guide explains how to structure premium-financed life insurance within an irrevocable life insurance trust (ILIT) and compares alternative trust vehicles, lender mechanics, and practical considerations for clients in New York City, Los Angeles, San Francisco, Houston, Dallas, and Miami.

Why combine premium financing with an ILIT?

• Estate-tax exclusion pressure: With federal estate tax exemptions shifting and state estate taxes varying, HNW families want durable strategies to keep life insurance proceeds out of a taxable estate. The federal exemption was indexed and materially higher than historical norms; always confirm current amounts before planning (see IRS guidance on federal estate and gift taxes for the latest figures). https://www.irs.gov/businesses/small-businesses-self-employed/federal-estate-and-gift-taxes
• Capital efficiency: Premium financing lets an insured buy a larger or more permanent policy than they could otherwise afford out-of-pocket—especially useful for older clients who need larger face amounts for wealth transfer.
• Creditor protection and control: An ILIT can provide creditor protection, spendthrift provisions, and clear trust administration rules for the insured’s heirs.

Core mechanics: ILIT + premium-financed policy (step-by-step)

1. Form the ILIT: Trustee (independent or bank trust department) is named; trust terms specify beneficiaries, distribution timing, and Crummey withdrawal powers if gifts will be used to pay premiums.
2. Trust executes application: The ILIT applies for a life insurance policy on the insured (trust is owner and beneficiary). This keeps proceeds outside the insured’s estate if properly structured and administered.
3. Borrow to pay premiums: A lender provides a premium finance loan to the insured (or the ILIT, depending on structure). Common lender types: private bank divisions of Bank of America, J.P. Morgan Private Bank, RBC Wealth Management, and specialist lenders. Typical lending terms reference SOFR + a spread (commonly in the ballpark of SOFR + 175–350 basis points, dependent on credit, collateral, and loan size).
4. Collateral and assignment: The policy is assignment-collateralized to the lender. The ILIT typically holds policy ownership and death benefit; trustee must manage collateral assignment, loan servicing, and premium streams.
5. Gift tax and Crummey notices: If insured makes gifts to the ILIT to service interest or collateral requirements, Crummey powers and timely notices are used to qualify gifts for the annual exclusion where appropriate.
6. Exit & payoff: At death, the ILIT receives the death benefit; the trustee uses proceeds to repay any outstanding loan amounts per loan documents, with residual distributed to beneficiaries. If properly structured, proceeds pass outside the deceased’s estate.

Key advantages and drawbacks

• Advantages

  • Estate inclusion avoidance: Properly done ILIT ownership keeps death benefit out of the insured’s estate.
  • Leverage: Access to larger policies without huge upfront premiums.
  • Flexible liquidity: Death benefit provides estate liquidity to pay taxes, equalize inheritances, or fund buy-sell agreements.

• Drawbacks / Risks

  • Interest-rate risk: Floating-rate loans can become costly; stress-testing is essential.
  • Credit & collateral risk: Borrower/ILIT must meet covenants; lenders require collateral and may call loans on default.
  • Policy performance risk: Universal life policies rely on crediting/illustration assumptions; underperformance can increase future premiums or loan exposure.
  • Complexity & costs: Legal, trustee, and lender fees can be substantial.

See related practical resources: Interest-Rate Risk and Stress Tests for Premium-Financed Policies: Modeling Scenarios and Negotiating Loan Documents: Covenants, Repayment Triggers, and Default Remedies for HNW Deals.

Comparing ILIT vs other trust vehicles

Lender structures, collateral and pricing (practical guidance)

• Common lenders: Private banking arms (e.g., Bank of America Private Bank, J.P. Morgan Private Bank, RBC Wealth Management) and specialty lenders. Most provide negotiated pricing and covenants tailored to HNW borrowers.
• Pricing insight: Lenders typically price loans as a reference rate (SOFR) plus a spread; spreads vary by borrower credit, product, and collateral. Expect spreads in the approximately 175–350 bps range on top of current market SOFR levels (confirm live pricing with your lender).
• Collateral: Collateral usually includes
  • assignment of the policy,
  • additional pledged assets (investments, securities),
  • possibly a letter of credit or parent guaranty for business owners.

For operational checklists and lender selection, see: Choosing the Right Lender and Insurer: Due Diligence Checklist for Premium Financing.

Tax and estate impact specifics (U.S. focus)

• Estate inclusion: If the insured retains incidents of ownership (IO) in the policy, the death benefit may be included in the insured’s estate. ILIT removes IO when properly administered.
• Gift tax: Gifts from the insured to the ILIT to pay premiums may use annual exclusions if Crummey powers are used. Large funding may implicate gift tax or require a portion of the lifetime exemption.
• Income tax: Death benefits are generally income-tax-free to beneficiaries under IRC §101, but loans and policy cash values have different income-tax characteristics.
• State estate tax: New York, Massachusetts, and several other states have state-level estate taxes with lower exemptions than federal—this is especially important for New York City and Boston-area clients.

For a deeper dive on the interplay of loans, imputed interest, and estate inclusion, consult: Tax and Estate Impacts of Premium Financing: Loans, Imputed Interest, and Estate Inclusion.

Illustrative numbers (examples for planning discussions)

• Example A — 60-year-old male, $10M guaranteed universal life (GUL) held in an ILIT:
  • Illustrative annual premium if paid out-of-pocket: $120,000–$280,000 (varies by insurer, underwriting class, and product guarantees).
  • Premium finance structure: collateralized loan for premiums, initial collateral reserve or down payment commonly 10–30% of the first-year premium or as negotiated.
• Example B — 55-year-old female, $5M indexed/universal life:
  • Annual premium range if paid: $40,000–$120,000 (illustrative).
  • Loan interest: presently often referenced to SOFR; verify live lender spreads.

Note: These are illustrative ranges—actual pricing varies by carrier (e.g., New York Life, Northwestern Mutual, Pacific Life, Lincoln Financial), underwriting, and product. For consumer-facing cost comparisons and sample quotes across ages and policy types, see Policygenius’s cost guides (useful baseline education): https://www.policygenius.com/life-insurance/how-much-does-life-insurance-cost/

Practical recommendations for advisors and families (U.S. HNW focus)

• Engage multidisciplinary team early: trust counsel (ILIT-specialized), life insurance broker, lender, and a bank trust officer.
• Stress-test the deal for rate shocks: model SOFR + 300 bps scenarios, policy underperformance, and collateral calls.
• Use reputable carriers with strong financial ratings (e.g., carriers like New York Life, Northwestern Mutual, Pacific Life and Lincoln Financial are frequently used in HNW planning).
• Document every step to avoid estate-inclusion traps: gift timing, Crummey notices, relinquishment of incidents of ownership, and trustee independence.
• Review state estate tax exposure for the insured’s domicile (NY, CA, MA, NJ, OR, etc.)—this alters the scale and urgency of planning.

Conclusion

Combining premium financing with an ILIT can deliver outsized estate tax and liquidity benefits for HNW clients in major U.S. markets—when executed with rigorous lender selection, conservative stress-testing, and meticulous ILIT administration. Work with experienced trust counsel and private-banking lenders to align loan covenants, policy design, and trust provisions so the death benefit achieves the intended estate planning result.

External references

• IRS — Federal Estate & Gift Taxes (official guidance): https://www.irs.gov/businesses/small-businesses-self-employed/federal-estate-and-gift-taxes
• Policygenius — How much does life insurance cost? (illustrative consumer cost guidance): https://www.policygenius.com/life-insurance/how-much-does-life-insurance-cost/
• Tax Foundation — Federal estate tax exemption (background on exemption levels and history): https://taxfoundation.org/federal-estate-tax-exemption/

Internal resources

• Premium Financing 101: Leveraging Debt to Acquire High-Value Life Insurance for HNW Clients
• Tax and Estate Impacts of Premium Financing: Loans, Imputed Interest, and Estate Inclusion
• Choosing the Right Lender and Insurer: Due Diligence Checklist for Premium Financing