Lately, I’ve been thinking more about estate planning. Part of it is just getting older. Part of it is having young children I want to protect no matter what. And part of it is watching the unsettling rise in political violence, which is a stark reminder that life can be cut short unexpectedly.

As I inch closer to death, I can’t help but wonder about estate tax planning and the potentially massive tax bill my family might face if we’re extremely fortunate. To get ahead of it, I started digging into how an irrevocable life insurance trust (ILIT) could help families save big on the so-called death tax.

Picture this fortunate estate scenario:

A couple in their 90s, let’s call them the Yamamotos, spent their whole lives saving and investing. They built a thriving small business in Honolulu, bought a few rental properties, and squirreled away some stocks that did surprisingly well over the decades. By the time they’re both gone, their estate is worth about $50 million.

Building multi-generational wealth sounds like the dream, right? Except there’s a nightmare twist: the IRS shows up with a 40% estate tax bill on everything above the exemption amount, which in 2025 is $13.99 million per individual, or $27.98 million for a married couple.

That means the Yamamotos’ estate owes roughly $8.8 million in taxes (40% of $22.02 million, the amount over the estate tax threshold for two people).

And here’s the problem: most of the Yamamotos’ wealth is tied up in their business and properties. The estate doesn’t have $9 million in liquid cash sitting around. To cover the bill, the executor may be forced into a fire sale, dumping assets below market value just to raise cash. Years of careful building and family legacy can get ripped apart in one swoop.

But there’s a better way. Instead of scrambling to liquidate assets under pressure, families can use life insurance to pay the bill. And not just any life insurance policy, but one wrapped neatly inside something called an Irrevocable Life Insurance Trust (ILIT).

Let me explain why this is one of the most underappreciated estate planning moves the wealthy can make.

The Magic of the Irrevocable Life Insurance Trust (ILIT)

Here’s the financial strategy: Instead of owning a life insurance policy in your own name, you create an ILIT and have the trust own the policy. When you pass away, the ILIT – not your estate – collects the tax-free death benefit. The ILIT can then provide liquidity to cover estate taxes or distribute what’s left to your heirs exactly as you instructed.

Why is this so powerful? Because any payout that goes into the ILIT is not counted as part of your taxable estate. Even if you have a giant estate and a giant life insurance payout, the IRS doesn’t get to double dip.

Let’s run some numbers:

Suppose our friend Mr. Yamamoto has a $10 million life insurance policy inside an ILIT. If he owned that policy himself, the payout would push his taxable estate up another $10 million. That’s another $4 million evaporating into taxes ($10 million X 40% death tax).

But with the ILIT in place? That same $10 million policy gets funneled into the trust, outside the IRS’s reach, and can be used to give the estate the liquidity it needs to pay the tax bill. The family keeps their real estate, their business, their investments, and avoids a panic fire sale. That’s a massive win.

An ILIT succeeds in removing the insurance from the estate. It does not deprive anybody of access to anything.

Flexibility: Beneficiaries, Trustees, and Even “Special Friends”

One of the great things about ILITs is flexibility. You can choose almost anyone as the beneficiary: kids, grandkids, business partners, even lifelong friends.

Historically, ILITs were also a discreet way to provide for unmarried partners or, let’s be honest, “special friends” outside of marriage. If an individual had a special friend they wanted to benefit for always being there for them physically and emotionally when their spouse was not, life insurance inside the trust was one way you could take care of that obligation.

Scandalous? Maybe. Practical? Definitely.

On a more traditional note, ILITs also let you add structure. Don’t want your grandkids blowing their inheritance on Bentleys and TikTok influencer gear? Fine. You can direct the trustee to release money only for college tuition or a down payment on a home.

You can also protect heirs from creditors, divorce disputes, and even their own bad decisions. Trust and life insurance laws are strong in most states, and combined together, they form a kind of legal shield.

Think of it as “money with seatbelts.”

How an ILIT Actually Works

The setup has to be precise to pass IRS scrutiny. That’s why you should speak to an estate planning lawyer to help you set it up. Here’s the playbook:

1. Create the ILIT – You (the grantor) set up the trust and name a trustee. This has to be “irrevocable” — meaning once it’s done, you can’t pull the money back out for yourself. A revocable living trust is one you can change.
2. ILIT Buys the Policy – Instead of you buying the life insurance policy, the trust buys and owns it. You fund the trust with cash so it can pay the premiums. Important: Don’t transfer an existing policy into the trust unless you’re sure you’ll live at least three more years. Otherwise, the IRS will pull it back into your taxable estate.
3. Notify Beneficiaries (Crummey Notices) – When you put money into the trust, beneficiaries technically have the right to withdraw it. The trustee has to send out “Crummey notices” (named after a taxpayer with great timing and a funny last name). Beneficiaries usually don’t take the money out, but the IRS requires this step for the trust to remain legit.
4. Trust Pays Premiums – After the notice period passes (usually 30–60 days), the trustee uses the cash to pay the policy premiums.
5. Death Benefit Provides Liquidity – When you pass away, the ILIT collects the death benefit. The trustee can then decide how to use the funds: provide liquidity to the estate to cover taxes, support heirs, or both.

For example, the ILIT might name your spouse as the primary beneficiary and your kids as secondary beneficiaries. That way, your spouse is taken care of, and whatever’s left passes to your children free of estate tax when your spouse later passes. Smart layering.

Pitfalls and Cautionary Tales

Like most good things in finance, ILITs come with caveats:

• Forget the Crummey notices and you’re toast. One lawyer recalled a client who tried to backdate notices using a laser printer, except the notices predated the invention of laser printers. The IRS wasn’t impressed. Result: the ILIT was voided, and the assets were dragged back into the taxable estate. Ouch.
• Watch out for oversized policies. Don’t let a life insurance salesman talk you into $40 million of coverage if your estate plan shows you only need $10 million. Permanent life insurance is expensive, and excess premiums can drain your liquidity.
• ILITs work best with permanent life insurance. Term life policies usually expire before estate taxes are due. But permanent policies (whole, universal, etc.) cost a hefty amount in premiums. You’ve got to weigh whether the coverage is worth it.
• Tax laws change. Today’s $13.99 million per-person exemption might not last, despite the passage of The One Big Beautiful Bill Act on July 4, 2025. If the exemption falls back to ~$5 million, many more families will be affected. Still, if your net worth is likely to grow, planning ahead with an ILIT can make sense.
• No take-backs. Once you lock money into an ILIT, it’s gone for good. Some families regret setting one up when times get tough later. Or perhaps you decide to aggressively decumulate wealth by YOLOing and giving enough away to charity that you end up way under the estate tax threshold when you die.

An ILIT Is Like A Pressure Release Valve

Estate taxes are often called the “rich person’s problem.” But here’s the reality: real estate appreciation, stock market gains, and business success can push families into taxable territory faster than they expect.

For the Yamamotos, sitting on a $50 million estate, the IRS’s cut is nearly $9 million. An ILIT is like a pressure valve. It takes the uncertainty and panic out of the equation by ensuring there’s cash available to pay Uncle Sam without dismantling the family legacy.

Is it perfect? No. It requires discipline, planning, and often some hefty life insurance premiums. But for families who want to avoid a forced fire sale and keep their wealth intact across generations, it’s one of the most practical estate planning tools out there.

As with all things money, the earlier you plan, the more options you have. Don’t wait until you’re 78 with your estate executor staring down the barrel of a multimillion-dollar tax bill. Talk to an estate attorney, run the numbers, and see if an ILIT fits into your plan.

Because if you don’t, the IRS might end up as your biggest heir, and they don’t even send thank-you notes.

Readers, do any of you have an ILIT set up inside an irrevocable trust? If so, how easy was it to create, and do you think it’ll be worth it? If you’re considering one, definitely consult an estate planning attorney, as I’m not one. At a minimum, make sure you’ve got a death file, a revocable living trust, or at least a will. Since death is inevitable, it’s on us to plan ahead so our heirs aren’t left scrambling once we’re gone.

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Jason’s analysis of his retirement plan shows that the simple path beats the efficient frontier. Is he right or is he missing something?

Minerva is worried about the impacts of tax inefficiency to her wealth. Are her investments properly located?

Scott feels frozen because he doesn’t understand the nuances of the efficient frontier. Where can he get a simplified explainer so he can start taking action?

Former financial planner Joe Saul-Sehy and I tackle these three questions in today’s episode.

Enjoy!

P.S. Got a question? Leave it here.

 

Resources Mentioned:

Episode 577-qa-the-efficient-frontier-was-perfect-until-hr-got-involved/ | Podcast Episode

Episode 547-ask-paula-we-have-2-million-at-40-now-what/ | Podcast Episode

Your Next Raise | Course

Asset Allocation Made Simple | Free Download

The Truth About Making the Efficient Frontier Work in Real Life

Acorns Bonus Link 

 

 

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Jason asks (at 02:24 minutes):   Is it possible that my simple portfolio is already outperforming the efficient frontier? Or am I misinterpreting the data?

I’ve been intrigued by the efficient frontier discussions over the past year, especially episode 577, where Joe helped a listener named Kelsey work through limited 401(k) options. As a public safety officer, I’m in a similar position. 

I have access to both a 457(b) and a 401(a), plus a pension that’ll provide a guaranteed income. So, I’ve been fairly aggressive with a 90/10 stock-to-bond allocation. According to Portfolio Visualizer, this mix has an expected return of 13.22 percent with a standard deviation of 14.33.

To compare, I asked ChatGPT to create a 90/10 allocation that would fall on the efficient frontier, using the funds available in my 401(a). It suggested 25 percent S&P 500, 25 percent large cap growth, 15 percent mid cap, 15 percent small cap, 10 percent international, and 10 percent bond.

But here’s the twist: when I plug that allocation into Portfolio Visualizer — using the 30 percent max weight guideline — the expected return drops to 12.9 percent with a higher standard deviation of 16.75. 

When I match the standard deviation of my current portfolio (14.33), the return drops even further to 11.65 percent, which seems contrary to what I’ve taken from your episodes. I thought the efficient frontier should help me increase returns for the same level of risk? 

I’m perfectly happy with a VTSAX-and-chill approach, but if the efficient frontier really can deliver better returns at the same risk level, I’d love to understand how to take advantage of it.

Am I misinterpreting something here?

Minerva asks (at 37:20 minutes):   What’s the best way to avoid paying unnecessary taxes on investments—without doing anything shady?

As we approach retirement, my spouse and I are starting to think about where our investments live. Up until now, we’ve focused almost entirely on tax-advantaged retirement accounts, but we’re ready to build out our brokerage account to complete our tax triangle.

That brings up a big question: Which types of funds belong in each type of account? 

Which investments are better off in IRAs or 401(k)s because they generate high tax drag? And which ones are more efficient to keep in a taxable brokerage because they throw off minimal gains along the way?

We’d appreciate a deep dive into tax-efficient asset placement—especially for those of us closing in on retirement.

Scott  asks (at 01:19:19  minutes): Do you have any straightforward resources that explain the efficient frontier and offer actionable steps for someone ready to move beyond a basic index fund strategy?

I appreciated Joe’s thoughtful take on the “VTSAX and chill” approach versus optimizing for the efficient frontier. I’m intrigued by the idea of taking 15 minutes to shift my portfolio toward something more efficient—but I’m not sure where to start. 

Part of the appeal of VTSAX is how simple and clearly defined the steps are, thanks to JL Collins. Are there any articles, videos, or guides that simplify the efficient frontier in the same way?

 

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Jared is attracted to the favorable terms of the annuity plan that his employer offers, but he’s hesitant to pay the opportunity cost of locking up his money now. What should he do?

An anonymous caller is struggling to find the efficient frontier with only three funds to choose from in his Thrift Savings Plan. Is there any hope for him?

Jack feels great about the funds in his portfolio, but he’s losing sleep over how to apportion them between his taxable, pre-tax and Roth accounts. What’s the best tax strategy for him?

Former financial planner Joe Saul-Sehy and I tackle these three questions in today’s episode.

Enjoy!

P.S. Got a question? Leave it here.

_______

Jared asks (at 1:41 minutes):  Is it wise to lock up part of my portfolio now in exchange for guaranteed income decades down the line?

I’m 45 with a net worth of $1.5 million and a 92 percent allocation to stocks. I’ve been comfortable with the risk—didn’t panic-sell during the Spring 2025 volatility—and I haven’t felt the need to shift gears… until now. 

While looking into diversification options, I came across TIAA Traditional, which is offered through my employer. I understand this as a two-part product. First, I contribute now and receive a guaranteed minimum return of three percent, but in practice it’s often four to six percent. 

Then, later in retirement, I can convert that into a fixed income annuity—with an 8 percent conversion rate based on historical averages. TIAA seems well-regarded, and the guaranteed income appears more generous than what’s typically available from other providers.

Still, this isn’t your usual volatility-reduction tool like a bond fund. And while some guests on this podcast have spoken positively about the role of annuities in retirement planning, this is more complex than a straightforward annuity product.

So I’m wondering: should I invest in this now, locking in favorable terms and guaranteed income for the future? Or should I stay flexible, keep investing in growth-oriented assets, and consider an annuity closer to retirement—even if the terms aren’t as attractive down the line?

How should I think through this decision?

Jack asks (at 18:06 minutes):  My wife and I feel good about our asset allocation, but we’re getting tripped up on our asset location. Between a taxable brokerage, pre-tax or Roth account, how do we figure out which fund is best suited for each account?

We only invest in three main funds: domestic stocks through Vanguard Total Stock Market Index (VTI), international stocks through Vanguard Total International (VXUS), and a sizable position in Fidelity Blue Chip Growth.

Should VXUS go in the taxable account to take advantage of the foreign tax credit? Or does its lower tax efficiency mean it belongs in a pre-tax account instead? Should VTI be in the Roth since it might have higher expected growth? 

And then there’s the Fidelity Blue Chip Growth fund. My wife and I don’t want to sell it, but I realize it’s probably the least tax-efficient of the bunch. So if we want to keep it, does it make the most sense to try to shift it into a tax-advantaged account?

In short, how should we think about placing these three specific funds across our different account types to make the most of tax efficiency—while still honoring our preferences and keeping things simple enough to stick with?

Anonymous asks (at 34:13 minutes):How do I apply the efficient frontier when my investment options are limited? I’m a government employee using the Thrift Savings Plan (TSP). I’ve been struggling to merge the idea of the efficient frontier with the limited funds available to me.

I’ve experimented with different mixes, but I haven’t found a way to reduce risk without also reducing returns significantly. We have just a handful of options: a fund that tracks the S&P 500 (C Fund), a small-cap fund (S Fund), and an international fund that excludes China (I Fund).

Right now, I’ve got 60 percent in the C Fund, 20 percent in the S Fund, and 20 percent in the I Fund. That seems like a solid mix to me, but I want to ask—how would you evaluate these options to get as close to the efficient frontier as possible, given the constraints?

 

Resources Mentioned:

Article 34 : Gold Hedge Againt Sequence Risk

Everything You’ve Ever Wanted To Know About Annuities 

How Should You Invest 1 Million

Retirement Planning with Dr. Wade Pfau

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