Insurance Curator Irrevocable Life Insurance Trusts (ILITs) are a cornerstone tool for high net worth (HNW) estate planning in the United States—powerful for keeping large life insurance proceeds out of the insured’s taxable estate, enabling tax-efficient wealth transfer, and protecting liquidity for estate taxes. But ILITs are also technical: small drafting or administrative errors can destroy the tax benefits and create unintended estate inclusion or gift-tax liability. This article, focused on advisors in major U.S. markets like New York City and San Francisco, explains the most common implementation mistakes and how experienced HNW advisors and private-bank teams avoid them.
Executive summary — why errors matter
- A misstep (retained incidents of ownership, failed Crummey notices, or improper premium financing) can pull a policy back into the insured’s estate or trigger gift-tax problems.
- Typical consequences: estate inclusion of policy proceeds, unexpected estate tax obligations, professional-fee disputes, and litigation risk for beneficiaries.
- Advisors mitigate these risks through precise drafting, documented procedures, timely notices, professional trustee selection, and stress-testing funding plans.
Sources for ILIT basics and tax mechanics: Investopedia’s overview of ILITs and Forbes’ practical summary are good primers; for gift-tax rules see the IRS gift tax guidance.
(Investopedia: https://www.investopedia.com/irrevocable-life-insurance-trusts-ilits-5189664, Forbes: https://www.forbes.com/advisor/life-insurance/irrevocable-life-insurance-trusts/, IRS gift tax: https://www.irs.gov/businesses/small-businesses-self-employed/gift-tax)
The 9 most common ILIT implementation mistakes (and mitigation)
1) Failing to remove all incidents of ownership
Mistake: The grantor retains any incident of ownership (ability to change beneficiary, borrow against the policy, surrender or exchange the policy) — this will generally pull the policy proceeds back into the grantor’s estate under Sections 2035–2036 of the Internal Revenue Code.
How advisors avoid it:
- Use clear, irrevocable assignment of an existing policy to the ILIT, or have the ILIT purchase the new policy with no retained rights.
- Ensure the grantor does not possess policy documents, change forms, or online account access; use trustee-controlled custody.
- Contractually prohibit the trustee from granting policy loans or changes without co-trustee/advisor sign-off.
Practical note: Banks and private trustees (e.g., Northern Trust, BNY Mellon Private Wealth) often provide custody and administrative controls to enforce separation of ownership.
2) Poorly executed gift transfers & missed Crummey windows
Mistake: The trustee fails to provide timely Crummey notices to beneficiaries after trust contributions intended for premium payments — jeopardizing the availability of annual gift-tax exclusion.
How advisors avoid it:
- Maintain standardized notice templates and automatic delivery (email + certified mail) within the statutory window (commonly 30–60 days after contribution).
- Keep logged proof of delivery and beneficiary acknowledgements.
- Pair Crummey windows with trustee resolutions and documented deposit dates so annual exclusion gifts (e.g., $17,000–$18,000 per donee in recent years — confirm with the IRS annually) are clearly traceable. (See IRS gift tax guidance.)
See in-depth procedures in Crummey Powers and Annual Exclusion Gifting: Making ILIT Contributions IRS-Proof.
3) Underfunding the trust / poor premium forecasts
Mistake: Advisors underestimate future premiums (especially for guaranteed UL or IUL indexed increases), leaving the trust unable to pay and forcing taxable distributions, policy lapse, or mid-term transfers.
How advisors avoid it:
- Stress-test 30-year premium scenarios using carrier illustrations and independent modeling.
- Maintain an ILIT treasury reserve or line of credit to cover volatility.
- Use staggered funding schedules or premium financing with a clear exit plan (see #6).
Reference: Compare funding frameworks in Funding Strategies for ILITs: Premium Payments, Gifts, and Trust Treasury Options.
4) Mishandling premium-financed policies
Mistake: Structuring premium financing without addressing potential "incident of ownership" issues, lender recourse, or death-proximity loan triggers — can create estate inclusion and counterparty risk.
How advisors avoid it:
- Use documented, arms-length loan agreements with non-recourse or limited-recourse terms where achievable.
- Ensure the ILIT—not the insured—owns the policy and that the insured has no ability to direct the lender’s actions.
- Model sensitivity to interest-rate swings; premium finance loans are typically indexed (SOFR-based) and can materially affect trust cash flows.
Practical vendor note: Banks and specialty lenders (private banks, boutique financing firms) price premium finance differently; advisors obtain multiple term sheets and evaluate the combined cost of financing plus lender covenants.
5) Choosing the wrong trustee
Mistake: Appointing an inexperienced individual trustee or an overburdened family member leads to missed notices, poor investment of trust funds, or conflicts.
How advisors avoid it:
- Recommend corporate or professional trustees for HNW ILITs (private bank trust arms, independent trust companies) that provide:
- Documented procedures for Crummey notices
- Custodial control of policy documents
- Experience with policy premium payment mechanics and Form 709/706 coordination
- Negotiate trustee fee and service levels up front (see fee table below).
6) Inadequate coordination with estate-tax and GST planning
Mistake: Failing to account for generation-skipping transfer (GST) tax or to integrate ILIT design with portability elections, QTIPs, and the estate plan of a spouse.
How advisors avoid it:
- Coordinate with estate counsel to allocate GST exemption at trust funding if multi-generational wealth transfer is intended.
- Run estate-tax projections for NYC and California domiciles where state-level taxes and rules (and possible state estate taxes) differ from federal rules.
7) Bad beneficiary drafting & inflexible distribution rules
Mistake: Overly rigid or ambiguous distribution provisions cause disputes and limit trustee flexibility to meet liquidity needs (e.g., paying estate taxes).
How advisors avoid it:
- Include trustee discretion for liquidity distributions, limited mandatory payouts, and clear fallback provisions.
- Provide examples and scenarios in the trust memorandum to guide trustee exercise of discretion.
8) Inadequate documentation of gift-splitting or spousal consent
Mistake: Spousal consent and gift-splitting forms not filed or documented correctly when a married grantor uses annual exclusion contributions.
How advisors avoid it:
- Use client intake checklists reflecting marital status and ensure Form 709 is prepared timely when required.
- Maintain signed gift-splitting consents in the ILIT file.
9) Poor post-mortem administration
Mistake: The trustee fails to handle policy claims, Form 706 valuation issues (if applicable), or timely beneficiary coordination — increasing administration costs and litigation risk.
How advisors avoid it:
- Provide trustees with a death checklist, grant access to the insurer’s claims team, and coordinate with tax counsel promptly for any estate tax returns.
Quick comparison: common mistakes vs advisor mitigation (cost impact)
| Mistake | Typical cost/risk | Advisor mitigation | Typical advisor-implemented cost |
|---|---|---|---|
| Retained incidents of ownership | Full estate inclusion; multi-million $ tax exposure | Assignment, custody controls, trustee ownership | $2k–$10k drafting + trustee custody fees |
| Missed Crummey notices | Loss of annual exclusion; gift-tax exposure | Automated notices, logs | $500–$2,000 per year admin |
| Underfunding / lapse | Policy lapse or taxable distributions | Stress-testing, treasury reserve | Reserve funded per plan; trustee fees annual 0.5%–1% of trust assets |
| Premium financing mis-structure | Loan recourse, estate inclusion | Multiple lenders, modeled exit strategy | Financing interest typically quoted at bank spread vs SOFR (varies); legal + modeling $10k–$30k |
| Trustee selection error | Administration failures, disputes | Corporate trustee retained | Institutional fees vary: flat + asset-based; large firms often 0.5%–1% of assets (see provider schedules) |
Note: trustee and financing pricing depends on provider and case complexity. Institutional providers like Northern Trust, BNY Mellon and regional private banks publish bespoke fee schedules—expect higher service levels (and fees) in New York and San Francisco markets.
Practical vendor and pricing notes (illustrative)
- Life insurers: carriers commonly used by HNW advisors include New York Life, Northwestern Mutual, MassMutual, and for simplified-term options Haven Life (MassMutual-backed). For term life, retail online quotes for healthy 40–45-year-old applicants can be in the range of a few dozen dollars per month for $1M 20-year term, while permanent coverage (UL/IUL/GLWB) will be materially higher and modeled via inforce illustrations (carrier-specific). (See carrier sites such as Haven Life for term channels.)
- Trustee services: institutional trustee pricing varies. Many private banks and trust companies charge a combination of an annual asset-based fee (commonly in the 0.5%–1.0% range for mid-sized accounts) plus administrative fees. Confirm current schedules with providers such as Northern Trust or BNY Mellon Private Wealth for NYC- or Bay-Area–based clients. (Northern Trust: https://www.northerntrust.com/)
Always obtain and compare carrier illustrations and trustee fee schedules for the client’s domicile (e.g., New York City and San Francisco have different state-tax and trust-administration nuances).
Final checklist for advisors implementing an ILIT
- Confirm trust drafting removes all incidents of ownership.
- Decide if the ILIT will purchase new coverage or receive an assignment; document and custody the policy.
- Establish Crummey notice protocol and maintain delivery proof.
- Model funding for worst-case premium increases and consider trust treasury or LOC.
- Vet trustee candidates (professional vs family) and negotiate service-level agreements and fees.
- If using premium financing, gather multiple lender term sheets and document exit strategy.
- Coordinate ILIT plan with income, estate, and GST tax planning; prepare Form 709s and, if needed, Form 706.
- Prepare a post-death administration checklist and ensure insurer claims contacts are in place.
For practical step-by-step drafting and trustee governance best practices, see ILITs Explained: A Step-by-Step Guide for High Net Worth Estate Planning.
Irrevocable Life Insurance Trusts deliver outsized estate-planning value for HNW clients—but only when implemented with disciplined drafting, documented administration, and active oversight. Advisors in New York, San Francisco and other HNW markets should treat ILIT setups as integrated multidisciplinary projects—legal, actuarial, tax, trustee, and lending—rather than one-off paperwork exercises.