Irrevocable Life Insurance Trusts (ILITs) and Crummey Trusts are two popular types of irrevocable trusts. How do you know which one is right for you? This article explains what these trusts are and when they make sense.

Key Highlights and Takeaways

• Two Powerful Estate Tax Strategies: ILITs and Crummey Trusts both save estate tax, but they’re used in different circumstances.
• ILITs are Extremely Tax Efficient: ILITs are highly tax efficient. The trust shelters the life insurance proceeds from estate tax, while the life insurance wrapper shelters the investment returns inside the policy from income tax.
• Crummey Trusts Optimize Around the Gift Tax’s Annual Exclusion: Crummey Trusts are designed to receive gifts of up to the donor’s “annual exclusion.” In 2024, a donor can give a donee up to $18,000 per year, increasing to $19,000 per year in 2025.

What is a Crummey Trust?

A Crummey Trust is a type of irrevocable trust that is designed to receive gifts that use up the donor’s gift-tax annual exclusion. In 2024, a donor can give a donee up to $18,000 per year without exceeding the annual exclusion amount. That amount will increase to $19,000 per year per donee in 2025.

Typically, a donor (the “grantor”) creates a Crummey Trust for each loved one whom he or she would like to help. For example, a grantor might create three Crummey Trusts: one for each of her three grandchildren. The grantor funds each trust — usually with liquid assets like stock, bonds, or cash — annually, in an amount up to the annual exclusion amount. Once an asset is in the trust, that asset is outside of the grantor’s estate and will not be subject to estate tax on the grantor’s death. Any resulting appreciation will also be outside the grantor’s estate. Because most Crummey Trusts are “grantor trusts,” the grantor has the option to pay the trust’s taxes, which is a way to transfer additional wealth to the trust. This makes Crummey Trusts even more estate-tax efficient than they would otherwise be. (You can learn more about Crummey Trusts here.)

Crummey Trust Example

Imagine that Serena is a New York City resident with a $25 million net worth and a portfolio that generates 9% annual returns (divided equally between capital appreciation and cashflow). If Serena sets up Crummey Trusts for each of her three grandchildren, and then contributes the annual exclusion amount to each trust each year, she’ll be able to move a significant amount of wealth out of her estate — $54,000 or more per year, plus appreciation. Serena will also be able to pay each trust’s income taxes, which means the trusts will be able to keep their entire 9% pre-tax returns while shifting even more wealth out of Serena’s taxable estate. After 25 years, the Crummey Trusts’ assets will be worth about $6.4 million. And if Serena dies in Year 25, she will have saved her family about $2.8 million of tax because she set up these three Crummey Trusts.

Benefits of Crummey Trusts

1. Estate Tax Savings: The primary advantage of a Crummey Trust is its ability to transfer assets to a grantor’s beneficiaries free of gift tax or estate tax.
2. Asset Protection: A Crummey Trust, as a separate legal person, is generally not subject to liability for actions taken by a trust’s grantor or beneficiary. So the grantor’s or beneficiary’s creditors won’t be able to access the trust’s assets even if they win a lawsuit against the grantor or beneficiary. In addition to protecting assets from lawsuits, Crummey Trusts can help shield inherited assets from a divorcing spouse.
3. Potential Income-Tax Savings: Although Crummey Trusts are generally set up as “grantor trusts,” which means they are ignored for income-tax purposes, they can be set up as “non-grantor trusts,” which have the ability to avoid state income tax. They can also distribute appreciated property to beneficiaries who are in lower tax brackets than the grantor. If those beneficiaries then sell the appreciated asset, they will pay a lower tax rate than the grantor would have if the grantor had been the seller.
4. Relative Liquidity: Compared to many other tax strategies, Crummey Trusts have little impact on a grantor’s liquidity. As long as the trust is a grantor trust, the grantor can borrow from the trust or swap assets with the trust without any tax consequences.
5. Series of Smaller Gifts: Some people prefer making lots of small annual gifts versus making a few large gifts, since the smaller gifts are less noticeable and less likely to have a significant immediate impact on the grantor’s financial situation.

Drawbacks of Crummey Trusts

1. GST Inefficiency: Crummey Trusts are generally not exempt from the generation-skipping transfer (”GST”) tax, so in order to avoid GST tax, they tend to end when the beneficiary dies. This means that Crummey Trusts don’t function as dynasty trusts, unlike many intentionally defective grantor trusts and other popular trust types. Still, Crummey Trusts can be a powerful estate-tax strategy. They are often — maybe not at first, but eventually — paired with other strategies.
2. Irrevocability: When a grantor makes a gift to a Crummey Trust, the gift is irrevocable.
3. Not Ideal for Illiquid Assets: Crummey Trusts work very well when funded with liquid assets, but they are often not the best fit for gifts of illiquid assets, like real estate or privately held stock. When gifting illiquid assets to an irrevocable trust, it’s important to get the assets appraised for tax purposes. Appraisals cost money. The cost of an appraisal is negligible when the asset being gifted is worth millions of dollars, but it can be quite significant if the asset is only worth $15,000. Liquid assets like public stock don’t need to be appraised at all.
4. No Direct Control: Typically the grantor does not act as trustee of a Crummey Trust, though he or she can remove and replace the trustee at any time.

What is an ILIT?

An ILIT is a type of irrevocable trust that is designed to hold insurance. A person (the “grantor”) creates an ILIT for the benefit of one or more loved ones — such as children, grandchildren, a spouse, or siblings. Typically, the grantor funds the trust with cash, which the trust uses to acquire one or more life insurance policies, often on the grantor’s life. Once the life insurance policy is in the trust, it is outside of the grantor’s estate, and the proceeds will not be subject to gift tax, estate tax, or generation-skipping transfer tax. Because life insurance policies generally are not subject to income tax, ILITs are able to generate both income-tax savings (via the insurance policy) and estate-tax savings (via the trust). It’s possible for ILITs to own assets aside from life insurance, though generally they stick to holding life insurance policies plus a small amount of liquidity.

ILITs can hold any type of life insurance policy, from indexed universal life insurance (IUL) to term life insurance. But a specific type of variable universal life insurance policy, known as Private Placement Life Insurance (PPLI), works particularly well with ILITs and has become quite popular with high-net-worth individuals who are looking to transfer as much post-tax wealth to their family members as possible. Even after accounting for the fees that life insurance companies charge, an ILIT funded with PPLI will generally outperform other estate-tax strategies. (You can learn more about ILITs here.)

ILIT Example

Imagine that Ronald is a 40-year-old New York City resident with a $25 million net worth and a portfolio that generates 9% annual returns (divided equally between capital appreciation and cashflow). If Ronald sets up an ILIT and then contributes $6 million to fund premiums on a PPLI policy, he will use up $6 million of his lifetime gift tax exemption, but the investments in the life insurance policy will be able to grow outside of his taxable estate. Even after fees, the policy will generate more than 8% annual post-tax returns. Meanwhile, the insurance charges will pay for a generous death benefit. If Ronald dies in Year 25, his beneficiaries will receive roughly $59.9 million of cash proceeds from the ILIT, and the total tax savings for his heirs will be about $39.9 million relative to if Ronald had done nothing.

Benefits of ILITs

1. Estate Tax Savings: The primary advantage of an ILIT is that it can shelter the proceeds of life insurance policies from estate tax upon the grantor’s death. Since the federal estate rate is 40% and in some states the effective estate tax rates (federal + state) are as high as 52%, this is an important benefit. When PPLI and ILITs are used in conjunction, the combined tax savings can be quite significant.
2. Asset Protection: An ILIT, as a separate legal person, is generally not subject to liability for actions taken by a trust’s grantor or beneficiary. So the grantor’s or beneficiary’s creditors won’t be able to access the trust’s assets even if they win a lawsuit against the grantor or beneficiary. In addition to protecting assets from lawsuits, ILITs can help shield inherited assets from a divorcing spouse.
3. GST Efficiency: A person can allocate generation-skipping transfer (”GST”) tax exemption to an ILIT when the trust is first funded. As a result, the ILIT is a popular form of dynasty trust.

Drawbacks of ILITs

1. Cash Funding: ILITs are typically funded with cash or cash equivalents so that the ILIT can pay large upfront insurance premiums. If an ILIT is funded with an appreciated asset, that asset will likely need to be sold in order to pay the insurance premiums.
2. Irrevocability: When a grantor makes a gift to an ILIT, the gift is irrevocable.
3. No Direct Control: Typically the grantor does not act as trustee of the ILIT, though he or she can remove and replace the trustee at any time.

Should You Set Up a Crummey Trust or an ILIT?

Crummey Trusts and ILITs both save estate tax, but they’re used in different circumstances.

The gift tax’s annual exclusion is a major tax benefit, and Crummey Trusts help people maximize the value of that tax benefit. If you are looking for a way to make relatively small, annual gifts to trusts that are protected from creditors and tax efficient, Crummey Trusts may be a good fit. But Crummey Trusts are not suited for very large gifts because they’re generally not designed to be dynasty trusts that are exempt from the GST tax.

On the other hand, ILITs are better suited for large gifts. ILITs are highly estate-tax efficient, and gifts to ILITs are generally GST exempt, which means that ILITs can make distributions to grandchildren or great-grandchildren without the distributions triggering any GST tax. For donors who are under 65 years old and in a position to gift $3 million or more to an irrevocable trust, ILITs are a logical choice. Combining an ILIT with a PPLI policy will generally yield the highest post-tax return of any estate-tax strategy.

It is important to note that there are lots of other gift and estate tax strategies that may make more sense than a Crummey Trust or an ILIT, depending on circumstances. Those strategies are also worth exploring. Moreover, Crummey Trusts and ILITs are not mutually exclusive; many people set up both.

Conclusion

Crummey Trusts and ILITs are both powerful tax strategies. Crummey Trusts make sense for people looking to make smaller, annual gifts without using lifetime gift-tax exemption. ILITs make sense for people who are looking to make larger gifts and want to maximize their heirs’ tax savings.

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