At your death, the death benefits are payable to the ILIT, because the ILIT is not only the owner of the policy, it is also the beneficiary. The death benefits are then held and administered by the Trustee according to the ILIT’s specific terms.
The trustee can use those funds to provide liquidity to your estate or to pay your estate taxes. In most cases, those funds cannot be paid directly to the creditor, nor paid directly to the IRS in satisfaction of your estate taxes. To do so, would cause those proceeds to be taxable in your estate. One of the ways to avoid this result is to include a provision in the ILIT that it may lend your estate such amounts as are necessary to pay the estate tax or other debts or claims.
In that scenario, the cash goes to your estate (probably being managed under the terms of a revocable living trust). Your estate now has a “note payable,” and the ILIT has a “note receivable.” An integrated estate plan will often provide that if one or more trusts have virtually the same distribution instructions, they may be merged after your death. So after the taxes are paid, and the debts are settled, your RLT and your ILIT can merge, cancelling out the notes payable and receivable, and making distributions to your beneficiaries.
Another option is for the ILIT to purchase property at full market value from your estate, so your estate can use those proceeds to satisfy debts or to pay estate tax. When this strategy is used, it is again important that your estate plan be integrated so that whether money is coming from the revocable living trust or the ILIT, the result for the beneficiaries is the same—both in the distribution patterns and the protections.