How ILITs are reinventing legacy planning post-OBBBA
The One Big Beautiful Bill Act didn’t just change tax law — it changed family dynamics in estate planning. With fewer estates expected to face the federal tax, irrevocable life insurance trusts are being reimagined as tools to solve our clients’ most human and profound nontax challenges: preserving heirloom properties, funding education and, most critically, preventing the family disputes that wealth often ignites.
Today, the conversation has shifted. Instead of simply asking, “How do I avoid estate tax?” clients are asking a deeper question: “How do I protect my family’s values and assets, and ensure my wealth supports my legacy?” This new focus on family governance and protection makes the ILIT, which is primarily viewed as a tax-driven tool, arguably more valuable than ever.
The ILIT renaissance: Moving beyond the exemption
For decades, the volatility of the federal estate tax exemption — bouncing from $600,000 in the late 1980s to more than $10 million under the 2017 Tax Cuts and Jobs Act—made ILITs essential hedges against political uncertainty. The OBBBA finally offers stability, permanently increasing the federal exemption to $15 million (indexed for inflation) in 2026. With fewer than 0.1% of estates expected to owe federal estate tax, the ILIT conversation now focuses on its most compelling nontax benefits.
For most clients, the most effective planning tools are adaptable. The modern ILIT thrives because it solves problems that are immune to legislative change: liquidity issues, lack of control and potential family conflict.
Creative strategies for modern legacy planning
Strategically designed ILITs can transform potential conflict into lasting unity. Consider these examples:
- Preserving the beloved vacation home. Heirloom properties — the family cabin, the ranch —carry immense emotional value but are notorious for sparking disputes over upkeep, property taxes and usage. An ILIT can provide tax-free liquidity to cover expenses and establish equitable use rules, turning a contested asset into a unified legacy.
- Equalizing inheritances. When a closely held business or illiquid real estate is earmarked for one child, the others can feel sidelined. ILIT proceeds provide the perfect mechanism to “equalize” inheritances, ensuring fairness without forcing the sale of the primary asset.
- Incentivizing values and success. The ILIT structure allows distributions to be tied to milestones, such as graduation, launching a business or demonstrating financial responsibility. This not only allows wealth to be transferred efficiently but also reinforces family values across generations.
The peril of the pivot: Fiduciary duty and unwinding trusts
With the federal estate tax threat diminished, some clients consider unwinding existing ILITs and distributing the life insurance policy back to the insured. While the idea of simplifying a client’s plan can be appealing, trustees should proceed with extreme caution.
The ILIT trustee’s fiduciary duty is to the beneficiaries, not the grantor. Terminating a trust or distributing a valuable policy must be done in the best interest of the beneficiaries, who are giving up their right to a policy that is currently protected from creditors and estate tax.
Lessons from Khan v. Khan
The recent case of Khan v. Khan provides a necessary and powerful cautionary tale regarding this duty.
In this case, the trustee, who was not a beneficiary, surrendered a trust-owned life insurance policy on her ex-husband’s life and directed the proceeds into her personal bank account. The trust beneficiaries (her children) sued, and the court found a clear breach of fiduciary duty, emphasizing that she failed to act with loyalty, prudence and transparency.
This case is a cautionary tale for trustees and reinforces the necessity of:
- Adhering to trust terms. Does the trust instrument even allow for the action contemplated?
- Maintaining transparency. Beneficiaries must be notified and kept informed.
- Prioritizing loyalty. Any action must unequivocally benefit the beneficiaries.
A trustee contemplating unwinding an ILIT must document and demonstrate that the action is not only mechanically possible but truly in the beneficiaries’ long-term interest — otherwise, they face personal liability.
Beyond fiduciary risk, unwinding an ILIT can also trigger unintended planning consequences, such as pushing the estate value above thresholds that affect, for example, estate tax deferral for business interests under IRC Sec. 6166.
The enduring power of protection
In a high-exemption world, ILITs remain indispensable for liquidity, control and protection, as well as nontax benefits, including:
- State tax planning. Although the federal estate tax exemption is high, 12 states plus the District of Columbia still impose an estate tax, often with far lower thresholds. The ILIT remains an essential strategy in these jurisdictions to keep the life insurance proceeds out of both state and federal taxable estates.
- Creditor protection. For business owners and professionals in high-liability fields, the ILIT offers invaluable protection. The trust structure shields the life insurance policy’s cash value and death benefit from claims arising from bankruptcy, divorce, lawsuits and other third-party creditors.
The OBBBA offers us a moment of certainty in an otherwise volatile planning landscape. Yet seasoned practitioners know that tax laws are never immune to shifts in the political climate. That reality underscores the enduring value of ILITs – they deliver flexibility, control and protection that transcend legislative changes. Rather than dismantling proven structures, now is the time to reframe them as tools not only for tax efficiency but for family governance, creditor protection and legacy preservation. In this way, ILITs ensure that the wealth families build is the wealth their heirs actually receive, regardless of what tomorrow’s laws may bring.
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