Irrevocable Life Insurance Trusts in North Carolina: A Secret Weapon for High-Net-Worth Families
Life insurance is often thought of as simple protection for a family. But for high-net-worth families in North Carolina, it can create a hidden tax problem. Under federal law, if the insured owns the policy, the full payout may be pulled into their estate and taxed, even if the family needs that money just to cover costs.
An Irrevocable Life Insurance Trust, or ILIT, can solve this problem. This specialized trust keeps the life insurance policy outside of your taxable estate while giving your heirs cash when it’s needed most. For wealthy families with businesses, farms, or real estate in North Carolina, an ILIT can be the difference between a smooth estate settlement and a scramble to pay taxes and creditors.
And while North Carolina no longer has its own estate tax (it was repealed in 2013), the federal estate tax still applies. In 2025, the federal estate tax exemption is $13.99 million per person, and beginning in 2026 it increases to $15 million per person, or $30 million per married couple, adjusted for inflation. Families over that threshold, or families worried about future changes in Congress, still turn to ILITs as a tool to protect life insurance from estate taxes.
How an Irrevocable Life Insurance Trust Works in North Carolina
An Irrevocable Life Insurance Trust is exactly what it sounds like: a trust which cannot be changed once it’s created. The trust, not the insured, owns the life insurance policy. That one distinction makes all the difference.
When the insured dies, the life insurance proceeds are paid directly into the trust. Because the insured did not technically own or control the policy, the payout bypasses the estate. The proceeds are not included in the federal taxable estate, they are not tied up in probate delays in North Carolina courts, and they are distributed under the terms of the trust rather than by the default estate process.
Without an ILIT, a $5 million life insurance policy could inflate a $12 million estate into a taxable $17 million estate, crossing the exemption line and triggering a significant estate tax bill.
Why ILITs Still Matter for North Carolina Families in 2025
Since 2013, North Carolina has had no state estate tax. Many people assume this means estate planning with life insurance is not necessary. But the federal estate tax rules still apply, and they can create serious challenges for high-net-worth families.
Families with estates worth more than $15 million for an individual or $30 million for a married couple after 2026 are exposed to federal estate taxes. Even families below that threshold may need ILITs because their wealth is often tied up in illiquid assets such as farmland, commercial property, or family businesses. Selling those assets quickly to raise cash is rarely practical. An ILIT provides immediate liquidity to cover taxes and preserve property.
North Carolina law also provides valuable creditor protection for life insurance proceeds, but only if the payout is made to someone other than the insured or the estate. By ensuring the trust receives the proceeds, an ILIT preserves this protection. Families with blended households also rely on ILITs to ensure fairness in distributions. For example, one child might inherit the family business while other children receive life insurance proceeds through the trust. Even after 2025, with a higher federal exemption, ILITs remain an effective estate planning tool for wealthy North Carolina families.
How to Set Up and Fund an Irrevocable Life Insurance Trust in North Carolina
Creating an ILIT in North Carolina involves several steps. First, an estate planning attorney drafts the irrevocable trust document under state law. Because the trust cannot be revoked or amended, this drafting process requires careful thought. The insured cannot serve as trustee, so a trusted relative, friend, or professional fiduciary is usually appointed to manage the trust.
The trust must then obtain its own tax identification number and a separate bank account to keep funds distinct from the insured’s personal finances.
The ILIT then acquires life insurance. The best approach is for the trust to purchase a new policy. That avoids the IRS’s three-year rule, which would otherwise include the proceeds in the estate if the insured dies within three years of transferring an existing policy. If an existing policy is transferred instead, the family runs that risk. Some families attempt to sell a policy to the ILIT, but this raises another danger: the transfer-for-value rule, which can make the proceeds taxable income unless a limited exception applies.
Once the policy is in place, the insured makes annual gifts to the trust, up to the annual exclusion amount. The trustee notifies the beneficiaries of their temporary right to withdraw these funds (known as the Crummey notice) which is what qualifies the contribution as an exclusion gift. The trustee then uses the funds to pay the insurance premiums. Upon the death of the insured, the proceeds flow directly into the ILIT, outside of probate and free of estate tax.
Common Mistakes Families Make with Irrevocable Life Insurance Trusts
An ILIT is a powerful planning tool, but it is also vulnerable to errors which can undermine its benefits. One of the most common mistakes is running into the three-year rule by transferring an existing policy and then dying within that window, which pulls the payout back into the taxable estate.
Another problem is mishandling Crummey notices. If the trustee fails to send or document these notices, the IRS can deny the annual exclusion and treat the gifts as taxable.
The transfer-for-value rule is another trap. Families who try to sell or swap policies between trusts often stumble into this rule, which can cause the death benefit to lose its tax-free treatment.
Choosing the wrong trustee is also a frequent mistake. If the insured serves as trustee, the IRS can argue that the proceeds remain part of the estate. Even when another person serves as trustee, problems arise if the trustee does not monitor premium payments or policy performance.
A lapsed or underperforming policy can devastate the trust’s purpose, and failure to act prudently can be a breach of fiduciary duty.
Advanced strategies such as premium financing and split-dollar arrangements also come with risks. Rising interest rates can make premium financing unaffordable, and the IRS has challenged split-dollar structures in several court cases.
Medicaid planning adds yet another layer: moving a policy into an ILIT within five years of applying for Medicaid can trigger a penalty period. North Carolina families must also steer clear of stranger-originated life insurance, which violates the state’s insurable interest requirements.
Trustee Duties Under North Carolina Trust Law
North Carolina’s Uniform Trust Code, found in Chapter 36C of the General Statutes, sets strict fiduciary duties for ILIT trustees. Trustees must act prudently, which means carefully monitoring the policy’s premiums, loans, and performance. They must keep accurate records and maintain separate accounts for the trust’s funds. They are also required to provide beneficiaries with information and annual accountings under Section 36C-8-813. Trustees must act impartially, treating all beneficiaries fairly rather than favoring one over another.
These responsibilities are serious. For many high-net-worth families, the safest approach is to appoint a professional trustee or corporate fiduciary. A professional trustee understands both the financial complexities of life insurance and the legal requirements of North Carolina trust law, reducing the risk of costly mistakes.
Creditor and Beneficiary Protections in North Carolina ILITs
Life insurance proceeds in North Carolina are generally exempt from creditors if they are payable to someone other than the insured or the estate. If the estate is named as the beneficiary, however, creditors may reach the proceeds. An ILIT ensures that the proceeds are paid to the trust, preserving that exemption. The trust can then hold and distribute the funds according to its terms, protecting beneficiaries not only from creditors but also from divorce settlements, financial mismanagement, or other risks. This makes an ILIT especially valuable in blended families, where the trust can provide lifetime income for a surviving spouse while preserving the remainder for children from a first marriage.
Modern Strategies to Keep ILITs Flexible
Although irrevocable by design, ILITs are not frozen in time. North Carolina law allows for modernization through the state’s Uniform Trust Decanting Act, which gives trustees limited authority to transfer assets into a new trust with updated terms.
Families may also consider dynasty ILITs designed to last for multiple generations, protecting insurance proceeds from estate taxes each time wealth passes down. Some combine ILITs with spousal lifetime access trusts, allowing indirect access to benefits through a spouse while still removing the insurance from the taxable estate. Policy exchanges under Section 1035 of the Internal Revenue Code are another option, but they must be carefully handled to avoid triggering the transfer-for-value rule.
Frequently Asked Questions About ILITs in North Carolina
Is an ILIT still worth it in 2025 if my estate is under $30 million?
Even families below the federal estate tax threshold benefit from the liquidity, creditor protection, and distribution control an ILIT provides.
How do I keep life insurance out of my estate?
By having the ILIT own the policy, you remove incidents of ownership and keep the payout outside of your taxable estate.
What is a Crummey notice in an ILIT?
It is a written notice to beneficiaries giving them a short window to withdraw gifted funds. This process allows the gift to qualify for the annual exclusion.
What are the estate gift tax rule changes for 2025 in North Carolina and how do they affect life insurance trusts?
The annual gift exclusion is $19,000 per donee in 2025. Families often use this annual exclusion to fund premiums for Irrevocable Life Insurance Trusts (ILITs). To qualify as tax-free gifts, contributions must be properly documented with Crummey notices.
Can I transfer an existing policy into an ILIT?
You can, but if you die within three years, the proceeds are pulled back into your estate. The safer route is usually to have the ILIT purchase a new policy.
What happens if the trustee forgets to send Crummey notices?
The IRS may deny the exclusion and treat the contributions as taxable gifts.
Does my ILIT need to file a tax return?
Most ILITs are treated as grantor trusts and reported on the insured’s return. More complex ILITs may require their own filings.
Who should be trustee of an ILIT?
The insured cannot serve as trustee. Families typically select a trusted individual or a corporate trustee with experience in administering trusts.
Can life insurance in a trust help pay estate taxes?
Yes. The trustee can loan money to the estate or purchase estate assets, giving the estate the liquidity it needs.
Are ILIT proceeds safe from creditors in North Carolina?
Yes, provided the proceeds are not payable to the estate. An ILIT strengthens these protections.
Can an old ILIT be updated?
Sometimes. North Carolina’s decanting law allows trustees to make certain changes, although not every feature of the original trust can be rewritten.
Protecting Wealth Across Generations with ILITs in North Carolina
An Irrevocable Life Insurance Trust is more than just a tax planning tool. For high-net-worth families in North Carolina, it shields life insurance proceeds from estate taxes, creates liquidity to cover estate costs without forcing the sale of family property, protects heirs from creditors and poor financial decisions, and tailors distributions for blended families.
With the federal estate tax exemption at $13.99 million in 2025 and moving to $15 million in 2026, fewer families will face federal estate tax, but those who do often have complex estates which require careful planning. Even families under the threshold benefit from the creditor protection and control an ILIT provides.
The key is proper setup and careful administration. Done right, an ILIT becomes a reliable tool to preserve wealth for generations. Families in North Carolina who are exploring this option should review their estate plan now to decide whether an ILIT fits their needs and goals.
Schedule a free initial 15-minute consultation to help you understand whether an Irrevocable Life Insurance Trust is the right fit for your family’s estate plan.
