How to use life insurance to pay estate taxes

With the 2022 federal estate tax exemption amounting to $12.06 million ($24.12 million for married couples), it may seem unlikely that your heirs will be required to pay estate taxes under current tax laws. However, the law is expected to sunset at the end of 2025, with the exemption returning to an inflation-adjusted cost of about $6.2 million ($12.4 million for married couples). Unless Congress votes to increase the estate tax rate, many Americans will be at risk of having to pay more taxes. At a 40% tax rate, this can mean more money going to the Internal Revenue Service (IRS) on behalf of loved ones. In addition, your country may also have an estate tax. State deductions are usually smaller than federal deductions, so your state may collect more taxes when you die.

One estate planning tool in particular can be used to pay the tax on all or part of the house when a large part of the house consists of physical assets such as real estate, art, jewelry, collections, etc. If your goal is to keep these tangible assets in the family, a life insurance policy with an invariable insurance policy (ILIT) can be used to pay the estate tax, so the assets do not have to be sold.

IIT is a type of trust that is paid for your life by 1 or more. It is irrevocable, meaning that once you create an ILIT trust it usually cannot be changed or terminated. By converting and moving your life insurance to an ILIT, there are several benefits: you can avoid having the life insurance’s death benefit included in your estate for federal estate tax purposes; fund trusts and life insurance to help provide the money needed to pay estate taxes and other things after you die; and finally, having the power to control, through a trust deed, how and when the death benefit is used and to whom.

However, it is important to remember that this is an irrevocable trust. Once you transfer an existing policy to a trust or purchase a new life insurance policy using the trust, you must give up any right to change the policy or trust. If you retain any rights to the plan, such as being able to deduct the cost of the investment, the IRS and state tax authorities may consider you to still have an “ownership situation” and may require the plan to be included in your estate. Therefore, you must appoint someone such as your spouse, sibling, older child, or attorney to be the trustee of the ILIT. The trustee is in charge of managing the policies in the ILIT, and the life insurance will no longer be part of you.

To pay for life insurance, you transfer money to an ILIT and the trust pays the money. However, you should consider taxes. Investing in a security that someone can benefit from can be a gift. If each beneficiary’s premium payments exceed the gift tax threshold of $16,000 per year, gift tax may be owed.

One way to avoid this is to have the trustee send the beneficiaries a “Crummey letter” each time you transfer money to the trust. This letter will let them know that they can claim their share of the savings within a specific time frame. If they are entitled to income, the gift tax does not apply. However, those who will benefit from it may be foolish to withdraw the money because without this money the insurance premiums will not be paid and the policy will end. Eventually the death insurance premiums will exceed the premiums.

If you have an existing policy and transfer it to an ILIT, the IRS will still consider it part of your estate if you die within the next three years. (This does not apply to policies purchased by the trust.) is transferred to the ILIT at the end. Depending on a person’s age and life expectancy, this time may be very important to you.

Determining whether you are at a tax risk and whether an IIT makes sense for you may require coordination between your certified public accountant, your financial advisor, and your estate planning attorney. Because of the volatility of ILITs, all aspects of your financial life should be carefully considered.

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Effective June 21, 2005, new Internal Revenue Service regulations require that certain types of written instructions include a disclaimer. To the extent that the foregoing information contains written advice relating to a Federal tax matter, the written advice is not designed or written to be used, and may not be used by the recipient or any other taxpayer, to avoid Federal tax penalties, and is not written to assist in the promotion or marketing of goods or the issues discussed here.

The information contained in this report is for informational purposes only. All calculations have been made using methods that we believe are reliable but are not guaranteed. Please consult your tax advisor to review the information and discuss any questions you may have regarding this connection.

MEDIQUS Asset Advisors, Inc. does not provide tax, legal or accounting advice. This article is intended for informational purposes only, and is not intended to provide, and should not be relied upon as, tax, legal or accounting advice. You should consult your tax, legal and accounting advisors before taking any action.