How to Protect Life Insurance Proceeds from Taxes in 2026

Sabine Franco
Jan 14
2 min read

If you’ve taken the responsible step of purchasing a life insurance policy to protect your loved ones, the next step is making sure that payout actually benefits them, and isn’t eaten up by taxes.

Here’s what you need to know in 2026.

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Life Insurance Taxes: Who Pays What?

Spouse as beneficiary: If your spouse is the named beneficiary, life insurance proceeds are generally free from both income and estate taxes.
Children or other beneficiaries: If your children are beneficiaries, the proceeds are free from income tax but may be included in your taxable estate. Estate taxes can range from 35%–55%, meaning a significant portion of your legacy could be lost.

The Irrevocable Life Insurance Trust (ILIT)

An Irrevocable Life Insurance Trust (ILIT) is one of the best tools to protect life insurance proceeds from estate taxes, and in some cases, from creditors, divorce, or bankruptcy.

How it works:

The ILIT is the legal owner of the life insurance policy.
The trustee pays premiums directly or acquires the policy on behalf of the trust.
When you pass away, proceeds go directly to the trust’s beneficiaries, outside your estate, avoiding estate taxes.

Setting Up an ILIT

If you already own life insurance:Your ILIT trustee can either purchase the policy from you or you can transfer the policy into the trust. Certain rules apply, and we can guide you to avoid common pitfalls.
If you haven’t bought life insurance yet:Create the ILIT first, then have the trust purchase the policy. This avoids issues if you were to pass away unexpectedly, which could otherwise cause the proceeds to revert to your estate if death occurs within three years of transferring an existing policy.

Why an ILIT is a Smart Move

By placing your life insurance in an ILIT:

Proceeds are removed from your taxable estate
Beneficiaries receive more of your intended legacy
You can add protections against creditors, divorce, or other financial risks

In short, an ILIT ensures your life insurance does exactly what it’s meant to do: protect the people you love and leave a lasting impact.

This article is a service of The Ambitious Legacy Firm. We do not just draft documents; we ensure you make informed and empowered decisions about life and death, for yourself and the people you love. That's why we offer a Legacy Planning Session, during which you will get more financially organized than you’ve ever been before and make all the best choices for the people you love. You can begin by using the link below to schedule a call with our Client Services Director, who will be able to guide you on scheduling your Legacy Planning Session.

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