Using Irrevocable Life Insurance Trusts (ILITs) to Cover Washington State Estate Taxes

When facing the punishing Washington State estate tax, wealthy families and business owners often run into a severe 'liquidity crisis.' The state requires you to pay your tax bill within nine months of death. If your wealth is tied up in a Bellevue tech startup, a farm in Yakima, or illiquid commercial real estate in Seattle, your heirs might be forced into a fire sale to pay the Washington State Department of Revenue, Olympia. An Irrevocable Life Insurance Trust (ILIT) solves this perfectly by providing tax-free cash exactly when the estate needs it.

Creating an ILIT requires precision drafting, as a single mistake can invalidate the entire tax strategy. We highly encourage you to utilize our USA Lawyers directory to find an experienced Washington estate planning attorney to set up your trust and guide your trustee through the funding process.

Step-by-Step Process for Creating an ILIT in Washington

Governed by Wash. Rev. Code § 11.98.011 regarding the valid creation of trusts, setting up an ILIT is a highly formal process that permanently transfers ownership of a life insurance policy out of your hands.

Step 1: Setting Up the ILIT

The first step is for your attorney to draft the trust document. Because the trust is irrevocable, you cannot change the terms, name different beneficiaries, or cancel the trust once it is signed. You are the 'Grantor.' You will legally name the trust as the owner and beneficiary of a life insurance policy. To exist as a separate legal entity, the trustee must apply for an EIN by submitting Form SS-4, FED, Internal Revenue Service, Application for Employer Identification Number.

Step 2: Funding Premiums via Crummey Powers

Because the trust owns the policy, the trust must pay the annual premiums. When you give cash to the trust to pay those premiums, it counts as a gift. To ensure these gifts qualify for the annual federal gift tax exclusion, your lawyer will insert 'Crummey powers' into the trust. Based on the landmark case Crummey v. Commissioner, 397 F.2d 82 (US Court of Appeals for the Ninth Circuit 1968), the trustee must send written letters (Crummey Letters) to the trust beneficiaries every time you deposit money. This letter gives them a short window (usually 30 days) to withdraw the cash. If they don't, the trustee uses the cash to pay the life insurance premium, avoiding gift tax penalties.

Step 3: The 3-Year Lookback Rule for Existing Policies

You have two choices: have the ILIT buy a brand new policy, or transfer an existing policy you already own into the ILIT. Transferring an existing policy triggers a major trap under 26 U.S.C. § 2035. If you transfer an existing life insurance policy into the trust but die within three years of the transfer, the IRS and Washington State will pull the entire death benefit right back into your taxable estate. Therefore, having the ILIT purchase a new policy directly is almost always the safer route.

Step 4: Choosing a Corporate vs. Individual Trustee

You cannot serve as the trustee of your own ILIT. If you do, you retain 'incidents of ownership' and the tax strategy fails. You must name someone else. While many people name a spouse or adult child, utilizing a corporate trustee (like a bank or professional trust company in Washington) is often highly recommended. Corporate trustees are immune to family drama, understand the strict mailing requirements for Crummey letters, and guarantee that the trust operates precisely according to state and federal tax codes.

Costs of Setting Up an ILIT

While establishing an ILIT requires an upfront investment, it is minuscule compared to a 20% estate tax hit on a multimillion-dollar policy.

Keep in mind that if your premium payments exceed the annual exclusion amount, your CPA may need to file Form 709, FED, Internal Revenue Service, United States Gift (and Generation-Skipping Transfer) Tax Return.

How Long Does the Process Take?

Drafting the trust document usually takes an attorney 2 to 4 weeks. However, the longest part of the process is medical underwriting for the new life insurance policy, which can take 1 to 3 months. Once the trust is signed, the EIN is obtained, and the bank account is opened, the trustee can finalize the insurance purchase. Overall, expect the entire setup to take 2 to 4 months from start to finish.

Frequently Asked Questions (FAQ)