How Grandparents Can Use ILITs to Protect Future Inheritances in Pennsylvania

Key Takeaways:

A properly structured and administered irrevocable life insurance trust (ILIT) for grandchildren can help keep death benefits out of the insured grandparent’s taxable estate while creating a controlled inheritance for the next two generations. The challenge is funding it correctly. Pennsylvania families typically use a combination of annual exclusion gifts, properly issued Crummey notices, and a long-term funding plan tied to the policy's premium schedule. If premium gifts, notices, or trustee records are mishandled, the ILIT’s tax benefits may be harder to defend.

Grandparents often want to do something meaningful for their grandchildren — pay for college, seed a business, or simply provide a financial cushion when the time comes. A common tool for that goal is the irrevocable life insurance trust, or ILIT. The trust owns a life insurance policy on the grandparent, or on both grandparents, pays the premiums each year, and ultimately holds or distributes the death benefit for the grandchildren under terms the family chose years earlier.

The mechanics are straightforward in principle, but ongoing premium payments raise several practical questions. Our Pennsylvania estate planning lawyers walk Montgomery, Bucks, and Lancaster County families through the structure so the trust does what it is supposed to do — year after year, decade after decade.

Why Use a Life Insurance Trust for Grandchildren?

A life insurance policy may be included in the insured’s taxable estate if the insured owns the policy, retains incidents of ownership, or the proceeds are payable to the estate. For a high-net-worth Pennsylvania family approaching the federal estate tax threshold, that inclusion can increase the taxable estate and expose more of the estate to federal estate tax, which can reach 40%.

A properly structured irrevocable life insurance trust can address that problem by keeping the policy outside the grandparent’s estate. Because the trust owns the policy, the death benefit generally passes outside the taxable estate if the insured has not retained incidents of ownership and the plan avoids estate-inclusion rules such as the three-year rule for transfers of existing policies. 

Beyond tax savings, an ILIT gives grandparents the ability to:

• Stagger distributions so a grandchild receives funds at appropriate ages rather than as a lump sum at 18 or 21.
• Provide a layer of protection if a grandchild later faces divorce, a lawsuit, or creditor claims, depending on how the trust is drafted and administered.
• Provide for education, a first home, or a business launch using clearly defined trust terms.
• Skip a generation thoughtfully, with attention to the generation-skipping transfer (GST) tax.

How Premium Payments Actually Work

Once an ILIT is in place, the trust is the policy owner. The grandparent does not pay the insurance carrier directly. Instead, money moves in two steps:

• First, the grandparent makes an annual gift of cash to the trust, approximately equal to the premium due.
• Second, the trustee uses those trust funds to pay the premium to the insurance company on or before the due date.

Skipping the trust and paying the carrier directly can undermine the structure by creating gift-tax, record-keeping, and administration problems. Plus, it may make the ILIT harder to defend if reviewed by the IRS. As a best practice, premium gifts should be deposited into the trust account, and the trustee should make the premium payment from that account.

The Annual Exclusion and Crummey Notices

Gifts to an ILIT are often structured to qualify for the annual gift-tax exclusion, which is $19,000 per donor, per recipient in 2026. For a married couple, coordinated gifts or gift-splitting may allow up to $38,000 per beneficiary, if the applicable requirements are met. With several grandchildren as ILIT beneficiaries, the combined annual exclusions may cover some or all of the premium, depending on the policy size, number of beneficiaries, and funding design.

To qualify for the annual exclusion, a gift must be a present interest. A gift to a long-term trust normally is not. 

One common solution is to give beneficiaries a temporary withdrawal right and document that right with a Crummey notice. 

Each year a contribution is made, the trustee sends a written notice to each beneficiary (or the legal guardian of a minor beneficiary) explaining that the beneficiary has a limited window — typically 30 days — to withdraw their share of that contribution. Even if beneficiaries usually allow the withdrawal period to lapse, the withdrawal right must be real and meaningful so the contribution can qualify as a present-interest gift for annual exclusion purposes.

Crummey notices should be treated as an essential annual administration step, not paperwork that the family can do once and forget. They should be sent in writing each year a contribution is made, with proof of delivery kept in the trust file.

Funding Strategies Over Time

Premiums on a permanent life insurance policy can run for decades. A funding plan that works in year one will not always work in year 20. Common adjustments include:

• Layering annual exclusion gifts across multiple beneficiaries to reduce or avoid use of the donor’s lifetime gift and estate tax exemption.
• Using a portion of the lifetime exemption if premiums exceed available annual exclusions, while accounting for the 2026 federal estate and gift tax basic exclusion amount of $15,000,000 per person.
• Considering GST exemption allocations each year, so the eventual death benefit may avoid or reduce the generation-skipping transfer tax when it benefits grandchildren.
• Reviewing the policy itself by requesting an in-force ledger every few years, because some older policies require additional premiums later to keep coverage in force.

Pennsylvania Tax Considerations for Grandparents

Pennsylvania has its own inheritance tax in addition to the federal estate tax. Pennsylvania generally does not tax life insurance on the life of the decedent for inheritance tax purposes, provided the policy is not an annuity; however, other estate assets may still be subject to Pennsylvania inheritance tax. 

For taxable assets passing to grandchildren, Pennsylvania’s inheritance tax rate for direct descendants is generally 4.5%.

For families in Montgomery, Bucks, and Lancaster Counties, an ILIT often works alongside other strategies — revocable trusts, lifetime gifts, and charitable giving plans — to manage both layers of tax.

Where Pennsylvania Families Get Tripped Up

ILIT benefits can erode quietly, often because of small administrative misses. Watch for these issues:

• Premiums paid directly to the carrier instead of through the trust account.
• Crummey notices not sent in writing, not sent when contributions are made, or not documented with proof of delivery.
• A successor trustee never named, leaving the trust without authority when the original trustee can no longer serve.
• Policies allowed to lapse because no one tracked an underfunded premium schedule.

An ILIT review every few years — especially after a change in family circumstances or tax law — is the easiest way to catch these problems while they are still fixable. Our Pennsylvania estate planning lawyers help families in Montgomery, Bucks, and Lancaster Counties build, fund, and maintain ILITs that match the larger plan, including coordination with broader trust administration responsibilities when the time eventually comes to distribute proceeds to grandchildren.