A life insurance trust is a trust that is set up for the purpose of owning a life insurance policy. If the insured is the owner of the policy, the proceeds of the policy will be subject to estate tax when he dies. But if he transfers ownership to a life insurance trust, the proceeds will be completely free of estate tax. (The proceeds will be exempt from income tax either way.)

Given the current estate tax rate of 46%, a life insurance trust can save hundreds of thousands of dollars in estate taxes. However, there are several drawbacks to such an arrangement:
The Life Insurance Trust has a pretty daunting and unappealing name for what is in reality a very good way to reduce or eliminate the effect of estate taxes on larger estates.

Life insurance benefits pass to the beneficiary on death income tax free, BUT if you own the life insurance policy when you die your estate pay estate taxes on the total amount given to your beneficiary. In larger estates that would in effect reduce the value of the policy by half due to the amount of tax due the government. You can have your children own the policy, making gifts to them each year under the annual gift exclusion to pay the annual premium. Most clients however opt for a trust to own the policy instead. This trust is called a life insurance trust. The life insurance trust solves the problem of ownership by removing the value of the policy from being included in your estate and therefore removing the assets from exposure to estate taxes.