Is life insurance really tax free?

Life Insurance can be a wonderful estate planning tool when properly utilized. Not only does it provide income replacement in case of premature death, but it also provides liquidity in estates that may face significant Federal Estate Taxes.

You may have been told by your insurance broker that life insurance is “tax free” to your heirs/beneficiaries. Not so fast…let’s clarify what is meant by “tax-free.”

While the beneficiaries of a life insurance death benefit will typically receive that benefit free of any income tax, the total value of the death benefit will typically be included in the estate of the deceased individual for purposes of calculating Federal Estate Taxes. Remember, Estate Tax rates have fluctuated between 35 to 55 percent over the last decade. The estate tax exemption has fluctuated between $1 million and $5 million since 2001.

This occurs because as the owner of the policy, the deceased individual held the power to direct where the death benefit would be paid. Thus, the IRS considers the full value of the death benefit subject to Federal Estate Taxation.

To avoid Federal Estate Taxation on life insurance, you must simply avoid being the owner of the policy. The Irrevocable Life Insurance Trust (ILIT) is a simple and effective way to transfer life insurance proceeds “Estate and Income Tax Free” to your beneficiaries.


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