by John Stylianou, accountant
Life insurance is a valuable tool for estate planning. By having adequate life insurance to pay estate taxes, you can leave more to the next generation. The pitfall is that if you have any “incidents of ownership” in the policy, proceeds from your life insurance will be included in your estate and will be subject to estate taxes. “Incidents of ownership” include the right to cancel or assign a policy, revoke an assignment, use the policy as collateral for a loan, borrow the cash value, or change a beneficiary.
Who should own your policy? Life insurance policies can be owned in many forms: directly by you, by your spouse, by your children, or by a trust. Setting up an irrevocable life insurance trust during your lifetime to own the policy, or having a family member other than you own the policy, can avoid having the proceeds included in your taxable estate.
Removing life insurance from your estate avoids the potential estate tax of 37% to 49% on the proceeds of the life insurance.
Can you transfer ownership? If you transfer an existing policy to a trust or an individual, the proceeds will still be included in your taxable estate if the transfer has taken place within three years prior to your death. Depending on the value of the policy and other factors, the transfer may escape gift tax (and the generation skipping tax).
The drawback to transferring ownership of your life insurance policy is that you no longer have control over the policy, including the ability to change beneficiaries.
Smart planning will save taxes. Proper planning for the ownership of your life insurance is essential. Keeping life insurance out of your gross estate will leave more to your beneficiaries. Contact us if you would like details about this and other strategies that could reduce taxes on your estate.