It’s easy to underestimate your net worth. After all, without a crystal ball, the future value of your home and savings is hypothetical. What’s not hypothetical, however, is the fixed amount of the death benefit provided by your life insurance policy. Adding this often significant sum to your asset pool could expose your estate to Federal estate taxes. Fortunately, there are trusts that can exclude life insurance from an estate.
Many people assume that because death benefit proceeds from a life insurance policy are generally not considered taxable income to the beneficiary, a life insurance policy is out of the reach of the Internal Revenue Service (IRS). However, when the policy’s death benefits are added to the appreciated value of your home and savings, it may come as a shock to find that the value of your estate may exceed the applicable exclusion amount.
Taxpayers should be aware that, under current law, Federal estate taxes are repealed in 2010. However, according to the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), estate taxes will be reinstated in 2001, with an applicable exclusion amount of $1 million and a top tax rate of 55%. Congress may retroactively change the rules before the end of 2010, reinstating the estate tax at the same or new levels.
Although the unlimited marital deduction allows spouses to transfer assets to each other without assessment of estate taxes, non-spousal heirs face the possibility of seeing a life insurance policy inflate an estate’s value past the scheduled exemption amount in the year of death.
One Strategy: A Credit-Shelter Trust
One way to protect life insurance policy proceeds from estate taxation is to use a type of bypass trust known as a credit-shelter trust. This trust can be established during life, even if left unfunded, or at death through a will.
For estate conservation purposes, a trust could be set up to maximize each spouse’s applicable exclusion amount, perhaps sheltering more assets from estate taxation than may be possible through use of just the unlimited marital deduction. At the death of one spouse, an amount equal to his or her applicable exclusion amount could pass to a trust to benefit the surviving spouse but intentionally designed not to qualify for the marital deduction, with the remainder of the assets passing outright to the spouse. Then, at the death of the surviving spouse, assets in the credit-shelter trust could be paid to the couple’s children—without being subject to Federal estate tax. Any assets outside the trust upon the surviving spouse’s death, and therefore potentially subject to estate tax, could be further sheltered by the second spouse’s applicable exclusion amount for that year.
Another Approach: An ILIT
Especially when children are intended to receive the proceeds of a life insurance policy and the owner wants to exempt the policy from the estate’s total worth, an irrevocable life insurance trust (ILIT) is another approach. In this case, the trust is the owner and the beneficiary of the policy. Keep in mind, however, the term “irrevocable” means beneficiaries may not be changed and loans for the benefit of the insured may not be paid out from the policy once it is put into the trust. Putting a hefty life insurance policy into such a trust could help beneficiaries finance the purchase of a family business or pay estate taxes. However, funding an ILIT may result in gift taxes due.
Park Your Policy in the Right Spot
A trust, depending on the type, can help reduce or defer taxes on high-value assets such as life insurance. More broadly, a trust can be the means to help ensure the policy’s benefits go directly to the intended beneficiary. With the flexibility of trusts, however, comes complexity. It is always best to consult with an estate attorney who is experienced in tax matters before proceeding.
MetLife, nor its affiliates, their agents, and representatives, may not give legal or tax advice. You should consult with and rely on your own independent legal and tax advisors regarding your particular set of facts and circumstances.
Copyright © 2010 Liberty Publishing, Inc. All Rights Reserved.
This article appears courtesy of Karl Susman. Karl Susman is a representative of the New Engl and Life Insurance Company. He focuses on meeting the individual insurance and financial services needs of people on the West Coast. You can reach Karl at the office at (424) 785-4337. New Engl and Life Insurance Company, 501 Boylston Street, Boston, MA 02116