Selling a Trust-Owned (ILIT) Policy: A Trustee Guide

ILITs are usually set up to keep a life insurance death benefit outside the insured's taxable estate and to provide liquidity for estate taxes or heirs. Circumstances change. The federal estate tax exemption has risen substantially over the last two decades, family needs shift, and universal life policies purchased years ago may now need far higher premiums than were originally illustrated.

When that happens, trustees often face a hard choice. The grantor may no longer want to make annual gifts to the trust to cover premiums, the trust may have little cash of its own, and the policy may be heading toward lapse. Letting the policy lapse or surrendering it for its cash value are common defaults, but they are not the only options.

A life settlement lets the trust sell the policy to a third-party buyer for a lump sum. A life settlement may produce more than the policy's cash surrender value, but results vary by case. A confidential life insurance policy review is usually the first step.

Before requesting offers, the trustee and trust counsel should confirm that the trust allows the sale. Key provisions to review include:

• Trustee powers: does the document expressly permit the trustee to sell, surrender, or exchange trust assets, including insurance policies?
• Restrictions: some ILITs direct the trustee to hold the policy until the insured's death or limit dispositions of the policy.
• Beneficiary notice or consent: the document or state law may require notice to beneficiaries, or it may be prudent to obtain their written consent.
• Distribution terms: how proceeds would be held or distributed after a sale, and whether that still matches the grantor's intent.
• Trust protector or decanting provisions: if the document is too restrictive, counsel may consider whether a trust protector or a decanting statute can provide flexibility.

A trustee generally must act prudently and in the beneficiaries’ interest. For a policy decision, that means comparing realistic alternatives, not just accepting the carrier’s surrender value or allowing a lapse. Our article on the fiduciary case for life insurance review explains why documenting this analysis matters.

The steps are the same as any life settlement, with extra attention to authority and documentation:

• Initial policy review and eligibility assessment. We review the policy details and the insured's general profile to assess whether the policy may have secondary-market value.
• Collection of policy and medical documentation. With authorization, we gather the in-force illustration, policy records, and medical records needed for underwriting.
• Medical and financial underwriting. Independent underwriting, including life expectancy reports, is coordinated to support a market-based valuation.
• Presentation to qualified institutional buyers. The policy is presented to qualified institutional buyers so that more than one market participant can evaluate it.
• Evaluation and negotiation of offers. Offers are reviewed, negotiated where appropriate, and presented clearly so the policyowner can make an informed decision.
• Completion of transaction documentation. If an offer is accepted, the required state disclosures and transaction documents are prepared and executed.
• Insurance carrier ownership and beneficiary transfer processing. The insurance carrier processes the change of ownership and beneficiary to the buyer.
• Closing and distribution of proceeds. The transaction closes and proceeds are distributed according to the transaction documentation.

Even though the trust owns the policy, buyers need the insured's medical records to estimate life expectancy. The insured will usually sign HIPAA authorizations and may need to agree to periodic contact after the sale so the buyer can track their status. Trustees should discuss this with the insured early, especially when the insured is the grantor and a family member.

Life expectancy estimates drive pricing. Our guide to the life expectancy report explains how underwriters use medical records.

The tax treatment of a sale depends on the trust’s structure. Many ILITs are grantor trusts for income tax purposes, which can mean the grantor reports the income; others are taxed as separate entities. Under IRS Revenue Ruling 2009-13 (as modified by Revenue Ruling 2020-5), proceeds may divide into a tax-free return of basis, ordinary income up to the policy’s cash surrender value, and capital gain on the remainder. Read our guide to life settlement taxation and the 1099-LS guide.

Trustees should also ask counsel about gift tax implications if the sale changes the trust's economics for beneficiaries, and about how proceeds will be invested or distributed. This article is not tax advice; involve the trust's CPA before signing.

• Letting a policy lapse without checking whether it has secondary-market value.
• Waiting until a grace-period notice arrives, which leaves little time to evaluate options.
• Accepting the first offer without a competitive process.
• Failing to document beneficiary communications and the reasons for the decision.
• Overlooking broker compensation; ask for it in writing before finalizing.

Selling a policy held in an ILIT is as much a family conversation as a financial one. The grantor usually created the trust with a specific goal, such as paying estate taxes, equalizing an inheritance, or providing for a surviving spouse. Before a sale, the trustee should understand whether that goal still exists and whether other assets now cover it.

Many trustees find it helpful to hold a short meeting or send a written summary that explains the policy's current status, the projected premiums, the options reviewed, and the range of outcomes under each. Beneficiaries who understand that a policy may lapse without further gifts are often more open to a sale than those who hear about it after the fact.

If beneficiaries disagree, trust counsel can advise on whether consent is required, whether a court instruction is prudent, or whether a partial solution, such as reducing the face amount or negotiating a retained death benefit, would better balance competing interests. Written records of these discussions help protect the trustee if the decision is later questioned.

Where the grantor is still living and is also the insured, the trustee should also be sensitive to the personal nature of the decision. The insured will be asked for medical records and may be contacted periodically after the sale, so their cooperation and comfort with the process matter.

Life settlement proceeds are paid to the trust as the policy owner through escrow at closing. From there, the trustee follows the trust document: proceeds may be invested for the beneficiaries, held for future distributions, or distributed under the terms of the trust. Trustees should plan how the proceeds will be invested before closing so that funds are not left idle, and should document how the new investments fit the trust's purpose and the prudent investor standard.

Accelerated Life Solutions works with trustees, estate planning attorneys, CPAs, and financial advisors, and directly with policyowners. We present qualifying policies to buyers, provide each offer for comparison, and coordinate the closing with trust counsel. Broker compensation is determined case by case, considering the circumstances and economics of each transaction, and is always disclosed before the transaction is finalized. Compensation is structured to support successful transactions while staying transparent with the appropriate parties. Applicable compensation and transaction costs are disclosed in accordance with governing state laws and transaction documentation.

Attorneys may also find our estate planning attorney life insurance review guide useful, and the ILIT premium relief case study shows a hypothetical example.