I don’t know why more Massachusetts families don’t use irrevocable life insurance trusts.
If you have accumulated enough wealth that some estate tax is likely unavoidable, your family will eventually need cash to pay it. An irrevocable life insurance trust, commonly called an ILIT, can use life insurance to create that liquidity, potentially delivering the money your heirs need for pennies on the dollar.
It is not a loophole. It is not an exotic strategy reserved for billionaires. It is simply a way to own life insurance outside your taxable estate when the trust is designed and administered correctly.
For the right Massachusetts family, it can be one of the most efficient tools in estate planning.
Massachusetts Has a $2 Million Estate Tax Threshold
The Massachusetts estate tax threshold is only $2 million.
That may sound like a lot, but consider what can be included in your estate:
- Your home
- Retirement accounts
- Investment and bank accounts
- Business interests
- Vacation property
- Certain life insurance proceeds
- Other property you own or control
In Massachusetts, a successful professional, business owner, or retired couple can cross $2 million without feeling remotely wealthy.
For deaths occurring on or after January 1, 2023, Massachusetts generally requires an estate tax return when the gross estate plus adjusted taxable gifts exceeds $2 million. Estates at or below $2 million are not subject to the tax, while estates above the threshold receive a credit of up to $99,600.
Massachusetts also has its own estate tax system. Being below the federal estate tax exemption does not mean you are safe from Massachusetts estate tax.
That distinction matters. Many people hear about the much larger federal exemption and assume they do not have an estate tax problem. In Massachusetts, they may be wrong.
The Estate Tax Creates a Liquidity Problem
An estate can be valuable without having much available cash.
Suppose most of your wealth is tied up in a closely held business, commercial property, a valuable home, or long-term investments. Your estate may owe tax, but that does not mean your heirs will have the necessary cash sitting in a checking account.
Where does the money come from?
Your family may have to sell investments at the wrong time. They might need to borrow money. They could be forced to sell real estate or part of a business. Or the tax could simply consume assets you intended to leave to your children.
Life insurance addresses that problem directly. It creates cash when the family needs it most.
But ownership matters.
Personally Owned Life Insurance Can Make the Problem Bigger
People often assume life insurance is automatically outside their estate because the death benefit is generally income-tax-free.
Income tax and estate tax are two different questions.
If you own a policy on your own life—or retain certain rights over it—the death benefit may be included in your taxable estate. Those rights are commonly called “incidents of ownership” and can include the power to change beneficiaries, cancel the policy, assign it, or borrow against it.
Imagine having a $3 million estate and purchasing a $2 million life insurance policy to help cover the estate tax. If you own that policy personally, you may have just created a $5 million estate for estate-tax purposes.
You added liquidity, but you may also have increased the tax bill.
That is where an ILIT comes in.
What Is an ILIT?
An ILIT is an irrevocable life insurance trust.
You establish the trust, choose its beneficiaries, and appoint a trustee. The trust then purchases and owns a life insurance policy on your life.
Because the trust—not you—owns the policy, the death benefit can generally remain outside your taxable estate if the arrangement is properly structured.
You make gifts to the trust, and the trustee uses that money to pay the insurance premiums. At your death, the insurance company pays the death benefit to the trust.
The trustee can then use the proceeds according to the trust’s terms. For example, the trustee may be able to:
- Lend money to your estate
- Purchase assets from your estate
- Provide for your spouse or descendants
- Hold and invest funds for future generations
A loan or asset purchase can give your estate the cash it needs to pay taxes and expenses without forcing your family to sell important assets.
Technically, the ILIT is not simply handing its money to your estate to pay the tax. The trustee must follow the trust and act in the beneficiaries’ interests. But the practical result can be exactly what the family needs: liquidity in the right place at the right time.
Why I Say “Pennies on the Dollar”
This is where life insurance becomes so compelling.
Suppose your family is projected to owe $1 million in estate taxes. Without planning, your heirs will need to find the entire $1 million.
It may come from an investment account, the sale of real estate, or money pulled out of a family business—but one way or another, your family is paying that bill dollar for dollar.
Life insurance gives you another option.
Depending on your age, health, and policy design, annual premiums of a few thousand dollars may purchase a death benefit many times larger than each year’s contribution. For older insureds or larger policies, the premiums will naturally be higher. But the principle remains the same: you are using comparatively small, planned payments to create a substantial pool of cash at death.
In the right case, a family facing a $1 million estate-tax liability can establish $1 million of life insurance to fund it. Instead of forcing the next generation to produce $1 million at once, the insured pays manageable premiums over time—and the insurance company ultimately supplies the $1 million.
That is what I mean by paying estate taxes for pennies on the dollar.
Of course, the total cost is not literally one small premium payment. It depends on how long you live, your health, the policy’s guarantees, and how the premiums are structured. But properly designed permanent life insurance can still create tremendous leverage.
You are taking a future liability that may cost your children $1 million and funding it today with substantially fewer dollars.
When the policy is owned by a properly structured ILIT, the death benefit can generally remain outside your taxable estate. You are not merely creating cash. You are creating cash in a way designed to avoid making the estate-tax problem even larger.
If the tax is likely to be unavoidable, I would much rather fund it strategically over time than leave my family scrambling to pay it dollar for dollar after I am gone.
A Simple Massachusetts ILIT Example
Assume a Massachusetts resident expects to leave an estate worth $6 million.
The family and its advisors estimate that Massachusetts estate taxes and related expenses will create a meaningful cash need. Much of the estate consists of real estate and a family business, neither of which the children want to sell.
An ILIT purchases a life insurance policy designed to provide enough liquidity to address the anticipated shortfall. The insured makes annual gifts to the trust, and the trustee uses those funds to pay the premiums.
At death, the policy proceeds are paid to the ILIT rather than directly to the estate. The trustee can then lend money to the estate or purchase assets from it.
The estate receives cash to pay taxes. In exchange for that cash, assets or a note can pass to the trust for the benefit of the family.
The children keep the business. The real estate does not need to be sold under pressure. The estate tax is funded through a strategy established years earlier.
That is the point.
Why Doesn’t Everyone Use an ILIT?
An ILIT is not right for everyone.
First, the trust is irrevocable. You cannot treat the policy like your personal property after the trust owns it. You should not retain the power to change beneficiaries, take policy loans, cancel the policy, or otherwise exercise control over it.
Second, an ILIT requires ongoing administration. Premium gifts, beneficiary notices—often called Crummey notices—and other formalities must be handled correctly.
Third, the insurance itself must make economic sense. The type of policy, carrier strength, guarantees, premium schedule, underwriting, and long-term performance all matter.
Finally, timing matters.
If you transfer an existing life insurance policy to an ILIT and die within three years of the transfer, the death benefit may still be included in your gross estate. Having the ILIT apply for and purchase a new policy can avoid that particular transfer problem, although the entire arrangement still needs to be designed and administered correctly.
These are reasons to plan carefully. They are not reasons to ignore the strategy.
Who Should Consider an ILIT in Massachusetts?
An ILIT deserves serious consideration when:
- Your current or projected estate exceeds $2 million
- Your estate is likely to owe Massachusetts estate tax
- A large portion of your wealth is illiquid
- You own a business or substantial real estate
- You want to preserve assets for your children or grandchildren
- You already own significant life insurance personally
- You expect some estate tax to be unavoidable
- You want to create predictable liquidity for your family
The earlier you explore the strategy, the more options you will generally have. Waiting can create underwriting problems, increase insurance costs, and make the three-year rule more significant.
The Bottom Line
If your Massachusetts estate is likely to face estate tax, somebody will eventually have to write the check.
The real question is where the money will come from.
It can come from the sale of investments, real estate, or a family business. It can come directly out of the inheritance you worked a lifetime to build. Or, with advance planning, it can come from life insurance held in a properly structured ILIT.
That is why I do not understand why more people use every strategy imaginable to reduce estate taxes but overlook the tool specifically designed to create cash when the tax becomes due.
An ILIT will not fit every estate plan. But if you have enough wealth that some estate tax is unavoidable, using life insurance to prepare for that liability may be one of the most practical decisions you make.
Why leave your family a million-dollar problem when you may be able to fund the solution today for a fraction of the cost?
– Michael Monteforte Jr.
Frequently Asked Questions About ILITs in Massachusetts
Does an ILIT eliminate Massachusetts estate tax?
Not necessarily. An ILIT is generally used to keep the life insurance death benefit outside the insured’s taxable estate and create liquidity to help the estate address its tax liability. It does not automatically eliminate the tax on your other assets.
Is life insurance included in a Massachusetts taxable estate?
It can be. If the insured owns the policy or retains certain incidents of ownership, the death benefit may be included in the gross estate. Proper ownership and beneficiary designations are essential.
Can an ILIT pay the Massachusetts estate tax directly?
An ILIT’s trustee must act according to the trust and in the beneficiaries’ interests. Rather than paying the estate’s obligation as a gift, the trustee may be authorized to lend money to the estate or purchase assets from it. That transaction gives the estate cash it can use to pay taxes and expenses.
Can I be the trustee of my own ILIT?
Serving as trustee can create control and estate-inclusion concerns. An independent trustee is commonly used so the insured does not retain prohibited control over the policy. The trustee selection should be made with an estate-planning attorney.
Can I transfer a policy I already own into an ILIT?
Possibly, but transferring an existing policy raises valuation, gift-tax, and three-year estate-inclusion issues. In many cases, it may be preferable for the ILIT to purchase a new policy from the beginning.
How much life insurance should an ILIT own?
That depends on the projected estate-tax liability, other estate expenses, existing liquidity, family goals, and the economics of the policy. The amount should be based on an analysis of the estate—not an arbitrary coverage figure.