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Is life insurance really tax free?
Grant Pederson • Dec 29, 2023
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.
Adding a child to your house title can lead to increased property taxes, loss of control, and exposure to the child’s creditors, while also forfeiting the step-up in cost basis benefit. Trusts offer a strategic alternative, allowing for controlled asset distribution, tax advantages, and protection from beneficiaries’ creditors.
Are you one of millions who setup your revocable living trust years ago and thought you were done? No question that a Revocable Living Trust (RLT) is a great, relatively simple, and effective estate planning tool. In fact, it is the core component of most estate plans. However, a RLT requires periodic review to ensure that it accurately addresses your family’s current circumstances and your ever changing goals. The following is a simple list of questions you should ask yourself on an annual basis to determine if your current plan is appropriate: Have there been any births, deaths, illnesses, or accidents in your family which would impact your distribution plan? Are your named beneficiaries competent and mature enough to receive the distributions pursuant to your current plan? Are any of your beneficiaries or heirs receiving or likely to receive any public assistance due to a disability? If so, please consider the appropriateness of a Special Needs Trust to protect that individual. Are the successor Trustees of your Trust and Executors of your Will all in good health and competent to serve in those capacities? Have all of your assets been changed to the name of the Trust and are your Schedules of Assets up to date? Specifically, have you purchased any new property or refinanced any old property, and have deeds been prepared to transfer that property into the name of the Trust? Has the size of your estate changed due to an inheritance, a new life insurance policy, or an increase in the value of investments, etc.? Are the attorneys in fact and health care agents for your Durable Powers of attorney in good health and still competent to serve in those capacities, or have those Powers of Attorney expired? If you have significant assets in tax-deferred or tax-free accounts such as 401k’s, IRA’s, Roth IRA’s, etc., do you understand your options regarding beneficiary designations, and how those designations will impact the estate and income tax planning aspects of your trust? New techniques are available to further protect these types of assets, without compromising the tax benefits associated with these tax-deferred or tax-free accounts. Additionally, you should also review your estate plan whenever a major change in the law occurs. At a minimum, we recommend that you sit down with your estate planning attorney to review your trust at least once every three years.
Do you own timeshare interests? If so, the following are a number of questions you may want to consider regarding your estate planning: How do you plan on distributing your timeshares to your beneficiaries when you're gone? Is it wise to make all of your kids co-owners after you pass? Did you purchase your timeshares with the hope that your kids and grandchildren could use them for years to come? Are you afraid they will be sold for a fraction of what you paid? If you're concerned about any or all of the above questions, perhaps you should consider adding Timeshare Trust provisions to your current revocable living trust. A Timeshare Trust is a way to hold title to all of your timeshare interests after you've passed. It will contain specific provisions to govern how the timeshares will be held for your family after you're gone. A Timeshare Trust allows you to designate one or more knowledgeable person(s) to manage the use of the timeshare properties or points. A Timeshare Trust can also ensure that the maintenance fees, insurance, and property taxes associated with timeshare ownership are paid proportionately by all beneficiaries. For example, the failure of a beneficiary to pay their fair share of the expenses could result in a forfeiture of use that year. Finally, a Timeshare Trust can ensure that these interests aren't sold unless a majority of the beneficiaries agree. A Timeshare Trust can be customized to meet your specific family circumstances and goals. When you use a Thousand Oaks estate planning attorney, they can assist you with the ins and outs of establishing a fool proof timeshare trust. Contact Pederson Law Offices if you're interested in learning more about how to plan for your timeshare interests.
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