Shielding Your Insurance from Estate Taxes
Life insurance, which can help to provide for your heirs in the event of your death, can be an important estate planning tool. It can provide funds to loved ones when they need it most and help meet your family’s financial obligations. One issue overlooked by many people, however, is that life insurance can add significant wealth to their overall estates, potentially causing assets to exceed the applicable exclusion amount of $5.49 million in 2017, the amount that can be sheltered from estate taxes. Fortunately, with proper guidance, it is possible to keep your life insurance policy proceeds out of your estate and also provide immediate funding for short-term financial needs.
You may already know that the inclusion of life insurance policy benefits in your taxable estate is contingent partly upon incidents of ownership. Policy proceeds cannot be excluded from estate taxation if you have held any incidents of ownership in the policy during the three-year period preceding your death.
In general, an incident of ownership is the right to exercise control over the policy or to receive an economic benefit from the policy, including any powers to surrender the policy, to pledge the policy as collateral, or to assign the policy and any reversionary interest equal to 5% or more of the value of the policy before death. Incidents of ownership also apply to any power to act as a fiduciary of a trust that holds insurance on your life if you established the trust, transferred the policy or consideration for the policy to the trust, or could have exercised any fiduciary power over the trust for your own benefit. On the other hand, your estate may not include your life insurance proceeds merely because you planned its purchase or gifted money used to pay premiums within three years prior to your death.
Again, entire policy benefits may be included in your estate unless all incidents of ownership are transferred more than three years before your death. In practice, the application of this rule is not always clear. Therefore, it is important to consult with your tax and legal advisers to ensure that your actions are consistent with your desired objectives.
Steps You Can Take
Here are some general guidelines you may want to discuss with your advisers. For new life insurance policies, proceeds are not included in the estate of the insured when another person (often an adult child or an irrevocable trust created by the insured) is the initial applicant and owner of the policy, or when the insured never possessed an incident of ownership in the policy.
If you want to keep life insurance proceeds on existing policies out of your estate, you need to transfer any incidents of ownership in the policy to another person at least three years before your death. In addition, make sure that your estate is not the beneficiary of the policy and that the policy beneficiary is not required to use policy proceeds to pay estate claims and expenses.
A Plan of Action
The above guidelines can help you develop a plan of action for keeping your life insurance proceeds out of your estate. Remember, before you take any action that might affect your policies, consider carefully all of the alternatives and seek professional counsel on how to best achieve your specific objectives.
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