Strategy Snapshot: Discounted Gifts Enable ILIT to Pay Future Life Insurance Premiums

Background

In 2026 the federal gift, estate, and generation-skipping transfer tax exemptions (currently $13,990,000 per individual), will change significantly, reverting to an estimated $7 million (as indexed for inflation).
Giving discounted assets to an irrevocable life insurance trust (ILIT) preserves gift/estate exemption by reducing the gift tax value of the gift. Lowered exemptions projected for 2026 and years following make saving exemption more important now than in recent years.

Case Scenario

Madison (57) has concerns about potential federal estate tax, as her net worth is $15 million and growing. Her portfolio includes income-producing investment real estate owned in a limited liability company (LLC) and nonqualified securities.

Madison has an ILIT that owns a whole life insurance policy on her life as well as other assets. She currently gives $150,000 each year to the trust to cover the premium due for that year. Some of the gift is protected from gift tax by her annual exclusions ($19,000 per person in 2025), but the balance of the gift reduces her lifetime exemption.

Upon advice of her personal estate planning attorney and financial professional, Madison decides to increase the ILIT’s holdings by making a large gift of her LLC interest in 2025.

Their Goals

Allow trust assets to grow outside of Madison’s taxable estate.
Provide liquidity to the executor of the estate, if necessary, to pay estate taxes.
Control management and distribution of trust assets to her children over time.

There are tax changes
on the horizon in 2026
that affect how gifting works.
An irrevocable life insurance trust
is one strategy that may make
transfers more tax efficient.

A Possible Solution

Instead of giving cash or securities, Madison will give non-voting interests of an LLC that owns income-producing investment real estate valued at $3 million. Working with her personal estate planning attorney and financial professional, Madison determines that although the given LLC interests represent 90% of all of the outstanding ownership, the value of the interests should be discounted by 25% to account for the non-voting character and transfer restrictions associated with the LLC’s operating agreement. As the LLC receives income, 90% of the distributed income will go to the ILIT, while the remaining 10% of distributed income will go to Madison, who is the 10% (and voting) member.

Madison transfers non-voting ownership interests representing 90% of the LLC to the ILIT in 2025. At the time of the transfer the value of the underlying commercial property is $3 million. Madison retains all voting interests, which represent 10% of the LLC.

Madison reports a gift of $2.25 million on a gift tax return in 2025. $2.25 million represents a 25% discount on a nominal transfer of $3 million.

Income distributed by the LLC from rental activity flows 90% to the ILIT and 10% to Madison.

The ILIT trustee will use some of the income to pay the life insurance premium and reinvest the balance of the trust’s share of LLC income in a balanced portfolio.

Madison will owe income tax on the trust’s taxable income since the trust is a grantor trust for income tax purposes.

At her death, the ILIT may buy assets from the estate using the cash provided by the life insurance death benefit.

After the grantor’s death, the ILIT holds or distributes assets to its beneficiaries, as determined by the provisions of the trust document.

Benefits & Drawbacks

Benefits

Madison’s transfer of discounted LLC interests uses $2.25 million of her gift exemption instead of $3 million if not discounted. Preserving $750,000 of gift/estate exemption will be important to Madison in 2026 when exemptions are reduced.
Appreciation of the real estate (the underlying asset of the LLC) from time of the gift will avoid transfer tax since the trust’s assets will not be included in Madison’s gross estate.
Additionally, the trust’s value grows faster since Madison is personally responsible for income taxes on any trust income.
Madison will not have to use any more of her exemption since the ILIT is projected to have enough income and principal to pay all future life insurance premiums, from either LLC income or the value of the LLC interests.
Madison retains control of the LLC that owns the real estate since she owns all of the LLC voting interest.

Drawbacks

The value of Madison’s retained LLC interests will be included in her gross estate when she dies. Since her 10% interest represents the voting and controlling interests, her interests might be valued higher than simply 10% of the underlying property.
Madison will include the trust’s taxable income on her personal tax return. She will owe income tax on 100% of the LLC and trust taxable income even though she only owns 10% of the LLC and the trust owns 90%.

For more information, contact a MassMutual Financial Professional.

Additional Resources

Any examples provided are hypothetical and for illustrative purposes only. Examples include fictitious names and do not represent any particular person or entity.

The information provided is not written or intended as specific tax or legal advice. MassMutual, its subsidiaries, employees, and representatives are not authorized to give tax or legal advice. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel.

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