Estate Planning and Tax Lawyer Blog

Just as most clients in the Jacksonville Florida area, life insurance can be one of the biggest assets in someone’s taxable estate. Yes, I said the word taxable estate. I want to discuss some ways life insurance can play a role within your estate plan but also some of the general rules regarding life insurance.

The first general rule is that if you are the owner of the life insurance policy, the death benefit of the life insurance will be included in your taxable estate. A lot of clients come in and talk to me about their life insurance and say it passes tax-free upon their death and so they do not worry about it. They are partially right. It passes income tax free. However, it may not pass estate tax free. Since the value of the death benefit is included in your taxable estate, your $2 or $3 million policy, dramatically increases your taxable estate.

To get around this potential estate tax, a lot of clients who have a large life insurance policy transfer ownership of the policy into an irrevocable life insurance trust (“ILIT”) that is run by someone other than the trust creator. By doing this, you are taking the value of the death benefit out of your taxable estate and the value of the death benefit in fact does pass completely tax free. Seems simple does it not? It isn’t.

If the current life insurance policy has any cash value built up within it, the transfer of that policy into the trust is a taxable gift up to the cash value amount. To avoid the gift tax, you will have to fall within one of the five exceptions to the gift tax that I wrote about on Monday. The easiest way to avoid the gift tax is to have enough beneficiaries in the trust to eat up the cash value through the $13,000 per year exemption. For example, if you have $50,000 of cash value in the policy but you have 4 children, you will be fine.

Another way to avoid the gift tax is to just purchase a new life insurance policy. In purchasing a new life insurance policy, you do not have to worry about the cash value because there will be no cash value. The Trustee right from the outset purchases a new policy in the name of the trust. A lot of clients will go this route through the use of a second-to-die life insurance policy. Second-to-die policies are nice because they are cheaper per year since they are based upon 2 lives and not just one.

I wanted to add a few words on the cost of life insurance. If you have policies that are older than 10 years old, it would be a good idea to have your policies reviewed to see if you can get it cheaper. About 10 years ago, they revised the way life insurance was priced because people are now living longer. If you have an old policy, you may be able to get the death benefit cheaper or get more death benefit for the same premium price. Speak to your insurance professional for the review as it is free.

Why am I saying so much about life insurance? Life insurance is a very useful way to leverage your assets to pass more onto your beneficiaries in a tax efficient manner. The life insurance policy must be owned a certain way for it to pass completely tax free.