How to Calculate ILIT Benefits for Estate Tax Planning

The Core Problem: Life Insurance Sits Inside Most Taxable Estates

Personally owned life insurance is included in your gross estate under IRC Section 2042. The IRS counts the full face value of every policy where you hold any "incident of ownership," including the right to change beneficiaries, borrow against cash value, or cancel the policy. A $5 million term policy you own outright adds $5 million to your gross estate on the day you die.

The federal estate tax exemption for 2024 is $13.61 million per individual. Estates above that threshold pay 40% on the excess. Without the Tax Cuts and Jobs Act extension, that exemption reverts to roughly $7 million (inflation-adjusted) after December 31, 2025. For a married couple with a $15 million estate and $3 million in personally owned life insurance, the insurance alone could generate a $1.2 million tax bill that a properly structured Irrevocable Life Insurance Trust would have eliminated entirely.

What an ILIT Actually Does to Your Tax Exposure

An Irrevocable Life Insurance Trust owns the life insurance policy instead of you. Because you hold no incidents of ownership and the trust is irrevocable, the death benefit is excluded from your gross estate under IRC Section 2042 and IRC Section 2041. The trust collects the death benefit, then distributes proceeds to beneficiaries according to trust terms. Those distributions carry no income tax liability for beneficiaries because life insurance death benefits are excluded from gross income under IRC Section 101(a).

The result is a transfer of wealth that bypasses both the 40% federal estate tax and the ordinary income tax that would apply to most other inherited assets above the stepped-up basis threshold.

How to Calculate the Estate Tax Savings from an ILIT

The savings calculation has four inputs: the gross estate value, the applicable exemption, the estate tax rate, and the life insurance face value.

Step 1. Determine taxable estate without the ILIT. Taxable estate = Gross estate minus applicable exemption.

Step 2. Calculate estate tax without the ILIT. Estate tax = Taxable estate x 0.40.

Step 3. Remove the insurance face value from the gross estate (simulating ILIT ownership). Adjusted taxable estate = (Gross estate minus insurance face value) minus applicable exemption.

Step 4. Calculate estate tax with the ILIT. Adjusted estate tax = Adjusted taxable estate x 0.40.

Step 5. Compute the savings. ILIT savings = Estate tax without ILIT minus adjusted estate tax with ILIT.

Worked Example 1: Single Taxpayer, $18 Million Estate

A 58-year-old single individual holds a $4 million whole life insurance policy personally. Total gross estate: $18 million. The 2024 federal exemption is $13.61 million.

Without ILIT: Taxable estate = $18,000,000 minus $13,610,000 = $4,390,000. Estate tax = $4,390,000 x 0.40 = $1,756,000.

With ILIT (policy removed from estate): Adjusted gross estate = $18,000,000 minus $4,000,000 = $14,000,000. Adjusted taxable estate = $14,000,000 minus $13,610,000 = $390,000. Adjusted estate tax = $390,000 x 0.40 = $156,000.

ILIT savings: $1,756,000 minus $156,000 = $1,600,000.

The ILIT does not eliminate the estate tax entirely here because other assets still exceed the exemption. But it removes $1.6 million from the tax bill while delivering a $4 million death benefit entirely to heirs.

Worked Example 2: Married Couple Planning Against 2026 Exemption Sunset

A married couple holds a $10 million estate today and a $5 million survivorship life insurance policy personally. They plan for the post-2025 exemption of approximately $7 million per person ($14 million combined with portability).

Without ILIT at the second death, assuming the full $10 million estate plus $5 million insurance proceeds: Total gross estate = $15,000,000. Combined exemption = $14,000,000. Taxable estate = $1,000,000. Estate tax = $1,000,000 x 0.40 = $400,000.

With ILIT: Gross estate at second death = $10,000,000 (insurance excluded). Taxable estate = $10,000,000 minus $14,000,000 = $0. Estate tax = $0.

ILIT savings: $400,000. The survivorship policy, now worth $5 million and held by the ILIT, transfers to children with no estate tax and no income tax.

The Three-Year Look-Back Rule: The Mistake That Costs Families Millions

Transferring an existing policy you already own into an ILIT does not produce immediate estate tax exclusion. IRC Section 2035 requires you to survive the transfer by at least three years. If you die within three years of moving the policy, the IRS pulls the full face value back into your gross estate as if the transfer never happened.

The correct approach is to have the ILIT purchase a new policy directly, with the trust as applicant and owner from inception. The three-year rule never applies to policies the ILIT originally owns.

Funding ILIT Premium Payments Without Triggering Gift Tax

Premiums paid into an ILIT are gifts to the trust. Two mechanisms keep those gifts tax-free.

Crummey Powers. The trust document grants each beneficiary a short window (typically 30 days) to withdraw new contributions. This right converts the gift into a present-interest gift, qualifying it for the annual gift tax exclusion of $18,000 per beneficiary in 2024. A couple funding an ILIT for three adult children can transfer $108,000 per year ($18,000 x 2 donors x 3 beneficiaries) with no gift tax and no reduction of the lifetime exemption.

Lifetime Gift Tax Exemption. Premium amounts exceeding annual exclusions consume a portion of the $13.61 million lifetime exemption (2024). Gifts filed on IRS Form 709 track cumulative use of that exemption.

A policy with a $90,000 annual premium funded by a married couple with two adult beneficiaries uses $72,000 in annual exclusions ($18,000 x 2 x 2) and reports only $18,000 on Form 709 against the lifetime exemption.

Calculate Your Numbers Before the Exemption Drops

The post-2025 exemption reduction is the single most important deadline in estate planning for the next 18 months. Estates between $7 million and $13.61 million per person currently face no federal estate tax. After December 31, 2025, those same estates could face a 40% bill on assets that were fully exempt the year before.

An ILIT established and funded before that date locks in the current higher exemption on the insurance proceeds. Waiting until 2026 may mean transferring the policy under the new lower threshold, shrinking or eliminating the tax benefit.

Run your gross estate, current exemption, and insurance face value through the CalcMoney Tax Calculator to see your exact exposure. The calculator outputs your taxable estate, projected tax bill, and the dollar impact of removing life insurance from your gross estate. That number tells you whether the cost of establishing an ILIT, typically $3,000 to $7,500 in legal fees, pays off in your specific situation.

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Results are estimates for informational purposes only. Consult a licensed financial professional before making financial decisions.