How to Terminate an Irrevocable Life Insurance Trust (ILIT)

Most irrevocable life insurance trusts were built to solve one problem: the federal estate tax. If your family set one up in the 1990s or early 2000s, the exemption at the time was somewhere between $600,000 and $1 million, and a life insurance payout could easily push an estate over the line. Moving the policy into an irrevocable trust, an ILIT, kept the death benefit out of the taxable estate.

As of 2026, the federal estate tax exemption is $15 million per person, $30 million for a married couple, effective January 1, 2026 and indexed for inflation in later years. No sunset is scheduled, though a future Congress could change the law. For a large share of the families who created ILITs, the tax the trust was built to beat no longer applies to them, and what remains is the annual routine: gift checks to the trust, withdrawal letters to the beneficiaries (the Crummey notices), premium payments out the other side, all to maintain a solution to a problem that may no longer exist.

This guide is for the person who created one of these trusts, the adult son or daughter serving as trustee, and the advisor helping either of them. It walks through every realistic way to undo an ILIT, the tax rules that come with each, and the one step a trustee should put on file before choosing any of them. It is general education, not legal or tax advice; the trust document and state law decide what is actually possible, and a trust attorney should drive any termination.

Why Families Are Unwinding ILITs in 2026

The estate tax math has moved a long way in one direction. The exemption was $600,000 through most of the 1990s, $5.49 million by 2017, doubled by the 2017 tax law, and then, in July 2025, set permanently at $15 million per person by the One Big Beautiful Bill Act. An ILIT funded in 1998 to protect a $2.5 million estate is now sheltering that family from a tax it will never owe.

When the Trust Is Still Doing Real Work

That does not automatically mean your trust is obsolete. A number of states levy their own estate or inheritance taxes at far lower thresholds, and an ILIT can still be doing real work there; our New York and Pennsylvania guides touch on two of them. The trust may also serve non-tax purposes: creditor protection, control over when heirs receive money, provisions for a family member with special needs. Whether the trust is still needed is a question for your estate attorney or CPA, and it deserves a real answer rather than an assumption.

When an ILIT Is No Longer Needed for Estate Taxes

But when the answer comes back “it is not doing anything anymore,” the reasons families act on it are usually practical rather than legal:

• The premiums keep rising. Many ILITs hold universal life policies whose cost of insurance has climbed with age, so the annual gift needed to feed the trust keeps growing.
• The gifting routine has become a chore. Writing checks, sending Crummey notices, tracking the paperwork, every year, for a purpose nobody remembers.
• The beneficiaries’ lives changed. The children the trust was meant to protect are now in their fifties and financially settled, or the family situation the trust assumed no longer exists.
• The trustee wants relief. A sibling or family friend who agreed to serve decades ago is still legally responsible for an asset nobody is watching.

What follows are the actual exits. Most articles on this topic stop at naming them. The differences between them, in dollars and in tax consequences, are where the real decision lives.

First, Look at What the Trust Actually Owns

Before weighing any exit, get two documents on the table.

The policy’s current statement and an in-force illustration. The carrier will provide both on request. Together they show the death benefit, the cash surrender value, the premiums required to keep the policy alive, and how long it survives if funding stops. Whether the policy is term or permanent shapes everything downstream: term coverage has no cash value and simply expires, while permanent coverage (whole life, universal life, guaranteed universal life) is an asset with a value that can be measured. One caution before writing off a term policy: some term contracts carry a conversion privilege that lets them become permanent coverage before a deadline. A convertible term policy can be worth real money, and that window closes on the carrier’s schedule, so check the contract before letting one quietly expire.

The trust document itself. Somewhere in those pages is the answer to which exits are legally available: whether the trustee may distribute the policy out, whether the grantor kept a substitution power, whether a trust protector can amend or dissolve the trust, whether there is a small-trust termination clause. A trust attorney can read it in an hour. The document, not any article, controls what is possible.

With those two in hand, the six exits below become a menu rather than a mystery.

If your question is narrower, how to get a life insurance policy out of an irrevocable trust, options 3 and 4 are the two that move the policy itself. The others turn it into cash or end the trust around it.

The Six Ways to Unwind an ILIT: Your Termination Options

Option 1: Stop Funding the Trust and Let the Policy Lapse

What it is. The grantor simply stops making the annual gifts. With nothing to pay premiums, term coverage ends, and a permanent policy coasts on its remaining cash value until it runs dry and lapses. Eventually the trust holds nothing and can be wound down.

When it fits. A term policy past its conversion window, or a permanent policy so depleted that nothing meaningful remains. Lapse is the exit of last resort because it is the only one that pays the family zero by design.

Watch out. Letting a permanent policy lapse without first checking its market value gives up an asset for nothing. Trustees should also be careful about lapse by neglect: a policy that dies because nobody was watching is hard to explain to beneficiaries later.

Option 2: Surrender the Policy for Its Cash Value

What it is. The trustee surrenders the policy to the insurance company, which pays the trust the cash surrender value, minus any surrender charges and any outstanding policy loan. It is fast, final, and requires nobody’s cooperation but the carrier’s.

When it fits. When the family wants out quickly, the policy has meaningful cash value, and its market value has been checked and found to be no better than the surrender value.

Watch out. Cash surrender value typically runs about 3 to 5 percent of a policy’s face amount (industry data), and the carrier’s payout is not a negotiated number; it is simply what the contract says. Surrendering is frequently the single most expensive shortcut in this list, which is why the valuation step in the next section exists. Our comparison of a life settlement versus surrendering walks through the difference on a single policy.

Option 3: Distribute the Policy to the Beneficiaries

What it is. If the trust document permits it, the trustee distributes the policy itself out of the trust to the beneficiaries, who then own it directly. The trust ends up empty; the coverage survives.

When it fits. When the children actually want the coverage on their parent’s life and are willing and able to pay the premiums going forward.

Watch out. The premium obligation follows the policy. A distribution that hands adult children an expensive universal life contract they never budgeted for often just relocates the problem. There can also be income and gift tax wrinkles depending on how the trust is structured, so this is a move to price out with the family’s CPA first.

Option 4: Swap the Policy Out or Buy It Back

What it is. Many ILITs give the grantor a substitution power: the right to swap assets of equivalent value into the trust and take the policy out, for example exchanging cash equal to the policy’s fair market value for the policy itself. Where there is no swap power, the grantor can sometimes simply purchase the policy from the trust at fair market value.

When it fits. When the grantor wants to keep the coverage personally, perhaps because health has changed and the policy is worth far more than its surrender value to the family that will eventually collect it, but the trust’s restrictions no longer make sense.

Watch out. Three tax points do the heavy lifting here:

• The swap power itself is generally safe. The IRS confirmed in Revenue Ruling 2011-28 that a properly structured substitution power does not by itself drag the policy back into the taxable estate.
• Owning the policy again puts it back in your estate. A policy the grantor takes back and keeps generally counts in the grantor’s own taxable estate for as long as the grantor owns it, because outright ownership is what the tax code calls an incident of ownership under Section 2042. With the exemption at $15 million that costs most families nothing, but it is the trade-off to see clearly.
• The three-year rule applies to gifts, not purchases. Code Section 2035 reaches gifts the insured makes personally, so giving the policy away again after a buyback and dying within three years can pull the death benefit back into the estate. A sale at full fair market value is generally outside that rule.

Everything here turns on the price being genuinely fair market value, which means the policy needs a defensible appraisal before it moves. When the ILIT is a grantor trust for income tax purposes, a sale between grantor and trust is generally not an income tax event, but that status is worth confirming rather than assuming. This is CPA and attorney territory; bring both.

Option 5: A Life Settlement While the Trust Still Owns the Policy

What it is. The trust, acting through its trustee, sells the policy to an institutional buyer for a lump sum: typically more than the cash surrender value, and always less than the death benefit. The buyer takes over the premiums; the cash lands in the trust. This is called a life settlement, and a trust-owned policy is eligible the same way an individually owned one is.

When it fits. When nobody in the family wants to keep paying for the coverage, the insured is a senior (typically 65 or older), and the policy is permanent or convertible term with a face value of roughly $100,000 or more. You can review the basic qualification criteria in a few minutes.

Watch out. The mechanics are simple but specific: the trustee signs for the trust as the owner, the insured signs medical record releases, and the beneficiaries generally do not need to sign unless the trust document says otherwise, though most states impose a duty to keep qualified beneficiaries informed, and many trustees notify adult beneficiaries as a matter of course. The proceeds belong to the trust, not the grantor, and are distributed under its terms. The process typically runs 60 to 90 days. Our guide to selling a trust-owned or ILIT policy covers the step-by-step process, who signs what, and the documents to gather.

Option 6: Terminate or Dissolve the Trust Itself

What it is. Ending the legal entity, not just emptying it. Depending on the state whose law governs the trust, that can happen several ways:

• Termination by consent of the grantor and all beneficiaries, which in many states needs a court’s blessing.
• A court petition to modify or terminate a trust when changes the grantor never anticipated mean it no longer serves its purpose. Courts weigh whether the trust’s original purposes still hold, so this is not automatic.
• A nonjudicial settlement agreement (NJSA) among the interested parties, in states whose law lets an NJSA go that far.
• Decanting the trust’s assets into a new trust with updated terms, which most states now allow, though this replaces the trust rather than ending the arrangement.
• A trust protector, if the document appoints one and gives that person power to amend or end the trust.
• A small-trust clause that lets the trustee dissolve a trust too small to justify administering.

When it fits. After the policy question is resolved. A trust holding sale or surrender proceeds, or nothing, is far simpler to wind down than one holding an in-force insurance contract.

Watch out. Every path in this option is a legal procedure under your state’s trust code, and the states genuinely differ; some allow NJSAs to terminate trusts outright while others reserve termination for the courts. This article can name the tools, but only a trust attorney licensed in the governing state can tell you which apply and run them. Beneficiary consent, notice requirements, and the trustee’s final accounting all live in that lane.

The Step Most Trustees Skip: Pricing the Policy First

Here is the part the estate-planning articles consistently leave out.

A permanent life insurance policy inside a trust is not just paperwork. It is the trust’s principal asset, and like any trust asset, it has a market value that may bear no resemblance to the number the insurance company will pay to take it back. Most families comparing their options see two figures: the cash surrender value on the statement, and zero. The figure they never see is what an institutional buyer would pay for the same contract.

The gap between those numbers is not small. In 2025, the average life settlement paid sellers $212,066, against an average cash surrender value of $24,360, nearly 9 times as much, across 2,955 completed transactions, according to the Life Insurance Settlement Association’s 2025 Annual Market Data. Individual results vary with age, health, policy size, and premiums, and not every policy qualifies. But the direction of the gap is stubborn, and on the large policies ILITs tend to hold, the dollars involved are serious.

For a trustee, this is more than a money question; it is a process question. A trustee’s job, at its core, is to deal prudently with what the trust owns. A trustee who surrenders or lapses a policy without ever checking its market value can never show the beneficiaries what that decision gave up. A trustee who checked can put the answer in the file and show the decision was an informed one, whatever the family chooses to do.

Whatever exit the family picks, the trustee who priced the policy first is the one whose file shows the trust pursued full value.

Checking costs nothing and commits you to nothing. And because different buyers price the same policy very differently, how it is checked matters: a single buyer’s quote is one opinion, while a policy shopped competitively reveals what the market will actually pay. That is the difference between asking one dealer what your car is worth and putting it up for auction, and it is why how offers get competed is worth two minutes of reading for any trustee weighing a surrender.

Sometimes the answer will be that the policy has no meaningful market value, and surrender or lapse really is the right call. That answer is worth having in writing too.

Before You Unwind: Reasons to Slow Down

This page is about how to get out of an ILIT, so it is worth saying plainly that sometimes the right answer is to stay in it. Three reasons to pause before anyone signs anything.

Coverage you give up may not be replaceable. A policy issued when the insured was 55 and in good health was priced on that health, and it cannot be repurchased later at that price. If the insured has developed a serious condition since, replacing the coverage may be costly or simply unavailable. The same health change that makes a policy valuable on the secondary market is the one that makes it hard to replace, so the family should know both numbers before choosing.

Permanent is not the same as forever. The $15 million exemption has no scheduled sunset, which is a real change from the last decade of planning. It still rests on a law a future Congress could amend. Unwinding a trust is straightforward; rebuilding one years later, at older ages and with whatever health has happened in between, is not.

Your state may still tax the estate. A family comfortably under the federal threshold can still face a state estate or inheritance tax at a far lower one. If the trust was doing double duty, ending it can solve a federal problem the family no longer has while creating a state problem it does.

None of this argues for keeping a trust that has genuinely outlived its purpose. It argues for making the decision with an estate attorney who knows your state’s rules, using real numbers rather than assumptions.

Which Exit Makes Sense? A Short Walk-Through

Getting out of an ILIT is a sequence, not a single decision. Families tend to get it backwards: they start with “how do we end the trust” when the trust’s ending is actually the last step, not the first. The productive order looks like this.

1. Does anyone still want the coverage? If the grantor or the beneficiaries value the death benefit and the premiums are bearable, the conversation is about restructuring, not exiting: a buyback or swap (Option 4), a distribution to children who will keep it (Option 3), or simply leaving the trust alone.
2. Is the policy term or permanent? Term with no remaining conversion privilege has nothing to price; when nobody wants it, lapse is honest (Option 1). Term that can still be converted deserves a phone call before its window closes.
3. If it is permanent and nobody wants to keep funding it, price it before touching it. This is the step above. Until you know whether the market values the policy at something like its surrender value or at several times that, every comparison the family makes is built on one number instead of two. You can run rough numbers in about a minute before making any calls.
4. Compare the real alternatives side by side. With a market number in hand, the choice becomes concrete: the settlement figure, the surrender value, the price at which the grantor would want to buy it back, or zero for a lapse. Each carries its own tax treatment, covered below. Our guide to how a trust-owned policy is sold, step by step covers the process if the family goes that route.
5. Then, and only then, wind down the trust. Once the policy has become cash or has left the trust, the termination itself (Option 6) is a clean legal task for the trust’s attorney, and where the trust holds little enough, its own small-trust clause may be the simplest route.

Taxes When an ILIT Is Unwound

Three federal rules come up again and again in ILIT exits. None of them should be navigated without a tax professional, and nothing here is tax advice, but you should recognize their names when your CPA raises them.

The three-year rule (Code Section 2035). This rule reaches transfers the insured makes personally, not distributions the trustee makes from a properly structured trust. It matters in two places here: a policy that was gifted into the trust less than three years before the insured’s death can be pulled back into the taxable estate, and so can a policy the insured takes back and then gives away again within three years of death. A bona fide sale for full fair market value is generally excepted, which is one of the quiet arguments for pricing the policy properly before it moves anywhere. And a policy the grantor simply takes back and keeps counts in the taxable estate for as long as the grantor owns it, with no three-year limit. For most families now far below the $15 million exemption, estate inclusion has no dollar consequence, but “does this still matter for us” is exactly the kind of question the trust’s CPA should answer on paper.

The transfer-for-value rule (Code Section 101(a)(2)). Life insurance death benefits are ordinarily income tax free. When a policy is transferred for valuable consideration, the death benefit can lose part of that exemption in the new owner’s hands, unless an exception applies; transfers to the insured are among the exceptions, which is what typically protects a grantor buyback. This rule is about who eventually collects the death benefit tax free, and it is the reason policy transfers between family entities should never be improvised.

Taxes on a policy the trust sells. When the trust sells the policy in a life settlement, any gain is taxed under the same three-tier federal framework that applies to individual sellers, set out in Revenue Ruling 2009-13, updated by the 2017 tax law, and conformed in Revenue Ruling 2020-05: basis comes back tax free, then a slice as ordinary income, then capital gain. Whether the trust or the grantor reports it depends on whether the ILIT is a grantor trust, and a non-grantor trust reaches the top bracket at a far lower income level than an individual does. The trust’s accountant can determine both quickly. Our life settlement tax treatment guide walks through the framework, the 1099s involved, and a worked example.

And the annual-gift housekeeping. Once premiums stop, the Crummey gift-and-notice cycle stops with them, which for many families is itself a small, welcome simplification at tax time.

Where Citizens Life Group Fits (and Where It Does Not)

A scope note, because a page like this should say plainly who wrote it and why.

Citizens Life Group is a licensed life settlement brokerage that represents you, the seller, and shops your policy competitively to maximize your offer. We work with policies of all kinds, including trust-owned (ILIT), survivorship, and other estate-planning policies. In a trust-owned case, the trustee signs as the seller. Citizens Life Group and its affiliated brokers are licensed in the states where they operate; contact us to confirm licensing and availability in your state.

We are not a law firm. We do not draft nonjudicial settlement agreements, petition courts, or terminate trusts, and five of the six exits on this page belong to your trust attorney and CPA, not to us. Our role is the step underneath all of them: telling a trustee or family what the policy itself is actually worth, by putting it in front of competing institutional buyers rather than guessing. There is no cost and no obligation to find out, no fees unless the policy sells, and every fee and commission is disclosed in writing before anything is signed.

That includes telling you when a settlement is the wrong move. If the policy’s market value turns out to be no better than its surrender value, or the smarter play for your family is a buyback or keeping the coverage in force, that is what we will say. Sometimes the right answer is to keep the policy.

Serving as trustee on a parent’s trust and not sure what you are holding? A ten-minute call answers most of it. Call (321) 270-0279, weekdays 9am to 8pm or weekends 10am to 8pm Eastern.

Frequently Asked Questions

Can you terminate an irrevocable life insurance trust?

Yes, in most cases, despite the name. The common paths are letting the policy lapse, surrendering it, distributing it to the beneficiaries, swapping it out or buying it back, having the trust sell the policy in a life settlement, or ending the trust itself under state law with the help of a trust attorney. Which paths are open depends on the trust document and the state law that governs the trust.

What are the options for terminating an irrevocable life insurance trust?

There are six realistic options: stop the annual gifts and let the policy lapse, surrender the policy for its cash value, distribute the policy to the trust’s beneficiaries, swap the policy out for assets of equal value or buy it back at fair market value, have the trust sell the policy in a life settlement, or terminate the trust itself through consent, a court petition, or a nonjudicial settlement agreement where state law allows. The right one depends on the policy, the family’s goals, and the trust document.

What happens to an ILIT if you stop paying the premiums?

If the gifts that fund the premiums stop, the trustee is left holding a policy headed toward lapse. Term coverage simply ends. A permanent policy may coast on its cash value for a time, then lapse with nothing paid to anyone. Before letting that happen, the trustee should find out whether the policy has real market value, because a lapse gives that value up for zero.

Can the grantor buy the policy back from the ILIT?

Often, yes. Many ILITs include a substitution power that lets the grantor swap in cash or other assets of equal value, and the IRS confirmed in Revenue Ruling 2011-28 that a properly structured swap power does not by itself pull the policy back into the taxable estate. A purchase at full fair market value also does not raise the three-year rule, because that rule applies to gifts the insured makes, not purchases. The trade-off: once the grantor owns the policy again, the death benefit generally counts in the grantor’s taxable estate for as long as they keep it. The price has to be genuinely fair market value, which is one more reason to have the policy appraised first. The trust’s attorney and CPA should handle the mechanics.

What is the three-year rule when a policy leaves an ILIT?

The three-year rule applies to transfers the insured makes personally, such as gifting an existing policy into the trust, or giving a policy away again after buying it back. If the insured dies within three years of that kind of gift, the death benefit can be pulled back into the taxable estate under Internal Revenue Code Section 2035. A bona fide sale for full fair market value is generally excepted, and a distribution made by the trustee of a properly structured trust is generally not caught by the rule. It matters most for families whose estates are still near the estate tax threshold; a tax professional can tell you whether it applies to your situation.

Should a trustee get a market valuation before surrendering a trust-owned policy?

It is a prudent step, and it costs nothing. In 2025, the average life settlement paid $212,066 against an average cash surrender value of $24,360, nearly 9 times as much, according to LISA’s annual market data. A trustee who checks the policy’s market value before surrendering can show the beneficiaries that the trust pursued full value, whatever the family ultimately decides. Individual results vary, and not every policy qualifies.

What is a nonjudicial settlement agreement and can it end an ILIT?

A nonjudicial settlement agreement, or NJSA, is a written agreement among a trust’s interested parties that resolves trust matters without a court proceeding. Many states that follow the Uniform Trust Code permit them, but states differ on whether an NJSA can terminate a trust outright: some allow it, others reserve termination for the courts. A trust attorney licensed in the state whose law governs the trust can tell you which paths are open.

What happens to the trust once the policy is gone?

Once the policy has been surrendered, distributed, or sold, the trust holds either cash or nothing. Cash proceeds belong to the trust, not the grantor, and are managed or distributed under the trust’s terms. Many trust documents include a small-trust provision that lets the trustee wind the trust down once it holds too little to justify administering. The formal termination and any final tax filings are handled with the trust’s attorney and accountant.

How do you get a life insurance policy out of an irrevocable trust?

There are three common routes, and all of them run through the trust document. The trustee can distribute the policy to the beneficiaries if the document allows it. The grantor can swap in cash or other assets of equal value using a substitution power, or buy the policy from the trust at fair market value. Or the trust can turn the policy into cash, either by surrendering it to the carrier or by taking it to the life settlement market, and then distribute the money instead. A trust attorney should confirm which route your document permits before anything moves.

What if one beneficiary will not agree to ending the trust?

Termination by consent generally requires the grantor and all beneficiaries to agree, so a single holdout can block it. That is one of the most common reasons families petition a court instead. Minor, unborn, or unascertained beneficiaries complicate matters further, because someone usually has to be appointed to represent their interests. Where state law allows a nonjudicial settlement agreement, that can sometimes resolve a disagreement without a full court proceeding. This is squarely a question for the trust’s attorney in the state whose law governs the trust.

Sources

• Life Insurance Settlement Association (LISA), 2025 Annual Market Data, released May 19, 2026
• Internal Revenue Code, 26 U.S.C. § 2035 (three-year rule), 26 U.S.C. § 2042 (incidents of ownership), and 26 U.S.C. § 101 (transfer-for-value), Cornell Legal Information Institute
• Internal Revenue Service, Revenue Ruling 2011-28 (substitution powers), Internal Revenue Bulletin 2011-49
• Internal Revenue Service, Revenue Ruling 2009-13 (how the sale of a life insurance policy is taxed), as modified by the Tax Cuts and Jobs Act of 2017
• One Big Beautiful Bill Act of 2025, H.R. 1, 119th Congress; Internal Revenue Service, Estate Tax
• Uniform Law Commission, Uniform Trust Code, including sections 411 (termination by consent), 414 (small trusts), and 111 (nonjudicial settlement agreements), as adopted state by state
• Tax Foundation, Estate and Inheritance Taxes by State

About This Article

Citizens Life Group is a licensed life settlement brokerage that represents you, the seller, and shops your policy competitively to maximize your offer, including trust-owned (ILIT), survivorship, and other estate-planning policies. This article is general education for grantors, trustees, and families, not legal, tax, or financial advice; trust termination is governed by your trust document and state law, and decisions about an ILIT should be made with a trust attorney and tax professional. Citizens Life Group does not provide legal or tax advice. Figures are drawn from LISA’s 2025 Annual Market Data, are year-stamped, and individual results vary. There is no guarantee that any policy will receive an offer.