Life insurance and estate planning

Ownership, irrevocable trusts, the three-year rule, and the election families miss

The federal exclusion is very large

For 2026, the federal basic exclusion amount is $15,000,000 per person. That's the amount you can pass at death without federal estate tax. It was set by legislation signed in July 2025, it is indexed for inflation for years after 2026, and it does not expire on a schedule.

That figure is worth pausing on, because a great deal of what's written about life insurance and estate tax was published when a large scheduled reduction was expected at the end of 2025. If you read an article describing an exclusion about to be cut roughly in half, check its date. The law changed.

With an exclusion that size, federal estate tax is not the reason most people should think about this. Three other reasons are:

• State death taxes, where thresholds run far lower. Oregon's starts at $1,000,000. We cover these on state estate and inheritance taxes.
• The portability election, which a surviving spouse loses by default if nobody files.
• Liquidity. If an estate is mostly a business, a farm, or property, the tax and the bills arrive in cash and the assets don't. That's the classic reason to hold life insurance in an estate plan, and it has nothing to do with the size of the exclusion.

Why your policy is in your estate at all

Section 2042 of the Internal Revenue Code puts two things into your gross estate: proceeds receivable by your executor, and proceeds receivable by anyone else if you possessed at your death any of the incidents of ownership in the policy.

Incidents of ownership is what decides it, and it is not about whose name is on the paperwork. The Treasury regulation says the term "is not limited in its meaning to ownership of the policy in the technical legal sense," and that it "has reference to the right of the insured or his estate to the economic benefits of the policy." It then lists what counts:

• the power to change the beneficiary
• the power to surrender or cancel the policy
• the power to assign it, or to revoke an assignment
• the power to pledge it for a loan
• the power to borrow against its cash value

A leftover interest that could return the policy to you also counts, but only if it was worth more than 5% of the policy immediately before you died.

So naming someone else as beneficiary does nothing on its own. If you can still change that beneficiary tomorrow, you hold an incident of ownership, and the proceeds are in your estate. Control is what the statute measures.

The irrevocable life insurance trust

The standard answer is to have someone else own the policy — usually an irrevocable trust set up for the purpose. It's common enough to have an abbreviation, ILIT, though the mechanism matters more than the label.

An irrevocable trust is one you cannot amend or revoke once it's made. That inflexibility is the point: you have genuinely given the property away, so it isn't yours at death. The trust applies for the policy, owns it, is the beneficiary, and pays the premiums with money you gift in.

The regulation gives its own worked example of the principle. Where a decedent irrevocably assigned his entire interest in a policy four years before his death and retained no reversionary interest, the proceeds were not includible in his gross estate.

How you can still undo it

You can hold an incident of ownership through the trust itself. The regulation is direct: a decedent is considered to have an incident of ownership in a policy held in trust if he has the power, as trustee or otherwise, to change the beneficial ownership in the policy or its proceeds, or the time or manner of enjoyment of them, even though he has no beneficial interest in the trust.

Read that carefully, because it's about the power, not the title. The question isn't "am I the trustee." It's "can I still steer who gets what, and when." That is why these trusts are drafted so that the insured cannot.

One narrower point, in case you meet it: a grantor's right to swap other assets of equal value for the policy is not by itself an incident of ownership, where the trustee has a real fiduciary duty to check that the values match and the power can't be used to shift benefits among beneficiaries.

The three-year rule

Here is the trap for a policy you already own.

Section 2035 pulls property back into your estate if two things are both true: you transferred an interest, or gave up a power, during the three-year period ending on the date of your death; and the property would have been in your estate under one of several sections, including Section 2042, had you kept it.

Applied to insurance: give your existing policy to a trust and die within three years, and the proceeds come back into your estate. The gift doesn't fail, it just doesn't achieve the tax result you wanted. There is an exception for a genuine sale for full value, which brings its own complications.

Where the trust applies for and owns a brand-new policy from the start, federal appeals courts have held the three-year rule does not reach the proceeds.

The reasoning is worth following, because the short version people repeat is imprecise. Your premium gifts to the trust are transfers, and that first condition is met as to the cash. The rule fails on the second condition. Gifted cash wouldn't come back under Section 2042, because you never held any incidents of ownership in the policy. As the Sixth Circuit put it in a case with exactly these facts, the trustee owned the policy from the time of application, and the insured's contributions toward premiums were irrelevant "because payment of premiums is not an incident of ownership under section 2042."

The practical consequence: if this structure is being considered, having the trust buy a new policy avoids a three-year wait that an existing policy would require. Whether that's the right answer depends on your health, your age, and what the new coverage would cost, which is exactly the kind of trade an adviser is for.

Getting money into the trust

The trust needs premiums, and you can't just pay them without consequence. Money you put into the trust is a gift to the trust's beneficiaries, and gifts are taxed.

The everyday shelter is the annual exclusion: for 2026 you can give $19,000 per recipient per year without it counting. Give to three beneficiaries and that's three separate allowances.

Except that it doesn't work here without one more step, and the reason is precise. The annual exclusion covers gifts other than future interests. It requires a present interest, meaning something the recipient can actually use now. A gift into a trust normally isn't that, because the beneficiaries get their money years later.

The Treasury regulation makes the point with a life insurance example of its own: where policies are transferred to a trust and the income payments to the beneficiary won't begin until after the insured's death, the transfer "represents a gift of a future interest in property against which no exclusion is allowable."

Crummey powers

The standard solution comes from a 1968 Ninth Circuit case, and the family's name stuck to the technique.

The trust gives each beneficiary a short window to withdraw the contribution when it's made. That right is real — it's the beneficiary's money to take if they want it. That makes the gift a present interest, so the annual exclusion applies. In practice most beneficiaries don't withdraw, because taking the money would defeat the plan their family is building. The court allowed the exclusions on the basis that the demand could not be legally resisted.

An example. You want to put $57,000 into the trust this year to cover a premium, and the trust has three beneficiaries. With withdrawal rights in place, that's three gifts of $19,000, each inside the annual exclusion, and the whole $57,000 is covered. Without them, the same $57,000 is a gift of a future interest, no part of it qualifies for the exclusion, and all of it eats into your lifetime exclusion instead.

Same money, same trust, same year. The withdrawal right is what makes the difference.

Beneficiaries get written notice. The Internal Revenue Service's position is that a withdrawal right qualifies a transfer as a present interest only where the beneficiary has notice of the right and a reasonable opportunity to exercise it. So trustees send a notice each time a contribution is made, and keep copies. If you are a trustee, this is the annual task not to forget.

The withdrawal amount is watched. When a withdrawal right expires unused, tax law treats the lapse as the beneficiary releasing a power, but only for the portion above the greater of $5,000 or 5% of the trust's assets. Above that line, letting the right lapse can itself be a taxable gift by the beneficiary, which is not what anyone intended. Drafting around this is routine, and it's one of several reasons these documents are not do-it-yourself.

Portability: the election families miss

This one costs real money and it's pure paperwork.

A married couple has two exclusions. When the first spouse dies without using all of theirs, the survivor can add the unused part to their own. The technical name is the deceased spousal unused exclusion amount, and at current figures the difference between capturing it and losing it can be many millions of dollars of shelter.

The catch is in the statute. That amount may not be taken into account unless the executor of the first spouse's estate files an estate tax return computing it and makes the election on that return. And no election may be made if the return is filed after the time prescribed by law, including extensions.

So a family whose estate is nowhere near taxable, who therefore has no obligation to file anything, and no accountant telling them to, loses the second exclusion by doing nothing. The return is due nine months after death, with an automatic six-month extension available.

An example with round numbers. A husband dies in 2026 having used $2,000,000 of his $15,000,000 exclusion. His wife survives him.

Thirteen million dollars of shelter, gone because nobody filed a form for an estate that owed no tax. That is the entire failure mode.

There is relief, and it's generous, so this is worth checking even years later. Estates that weren't otherwise required to file can use a simplified late election up to the fifth anniversary of the death, by filing the return with a specific statement written across the top of it.

Two more details. Only the most recent deceased spouse's unused exclusion counts, so remarriage changes the arithmetic. And the amount is measured at the first spouse's death and doesn't grow with inflation afterward, while your own exclusion does.

If you have been widowed in the last five years and no estate tax return was filed, this is worth one phone call to an estate attorney.

Skipping a generation

If a trust is meant to benefit grandchildren, a third tax enters.

The generation-skipping transfer tax applies to gifts and inheritances that skip a generation, money left to a grandchild rather than to a child. It exists so that a family can't avoid a round of estate tax by handing wealth down two generations at once.

The law counts three kinds of skipping transfer: a direct skip, a taxable termination, and a taxable distribution. A skip person is someone two or more generations below you, or a trust in which all the interests are held by such people.

It has no rate of its own. It uses the top federal estate tax rate in effect at the time, which is currently 40%.

Generations are counted through the family tree, so a grandchild is two below you. Legal adoption counts the same as blood, and a spouse sits in your own generation. For someone unrelated, age does the counting: a person born within 12½ years of you is treated as your generation, and someone born more than 12½ but not more than 37½ years after you is one generation below.

Two provisions worth knowing because they come up in real families. If a grandchild's parent has already died when the transfer happens, the grandchild moves up a generation and it generally isn't a skip. And tuition or medical costs you pay directly to the school or the provider aren't generation-skipping transfers at all.

There's a separate exemption for this tax, equal to the basic exclusion amount for the year. It has to be allocated, and once allocated the choice is irrevocable. That allocation is a decision someone has to actively make, which is the reason it belongs in a conversation with your attorney rather than in a filing cabinet.

Common questions

Last updated: July 23, 2026