Although benefits received from a life insurance policy are not treated as income for tax purposes, if the life insurance policy was owned by the decedent within three years of death, the decedent’s estate will be taxable. on any amount of insurance proceeds. above the wealth tax threshold. Ok, now in plain English. If you take out a life insurance policy on your own life, finance the policy during your lifetime, and leave the proceeds to your spouse or other family member, they will be taxed heavily. So what can you do to avoid this?
Creating an Irrevocable Life Insurance Trust (or “ILIT”) will protect your family from the burden of estate taxes upon receiving the benefits of the life insurance policy. These estate tax savings can be achieved if the insured establishes an ILIT and surrenders existing life insurance policies to the trust, or if the trust itself purchases a new policy on the life of the insured. The insurance will be excluded from the insured’s estate because the insured will not own the policy at the time of her death.
There are three requirements: (1) the insured must not own or retain any property incidents in the insurance, (2) the proceeds must be payable to the trust rather than the estate, and (3) if the policies are written by the insured to the trust, the insured must survive the gift for 3 years. To avoid any gift tax consequences, simply borrow against the existing life insurance policy for the amount of principal/value already achieved by the policy since it was instituted.
An ILIT also provides the benefit of educating who receives the money, at what age they receive the money, and under what conditions they can obtain the money. For example, you wouldn’t want your 7-year-old son to inherit $2 million all at once. How many sweets and video games do they really need? Instead, the ILIT can appoint a trustee and pay for the child’s needs until the child reaches a suitable age for inheritance, such as age 18, 21, or 25. You can see that your son is cared for but not given the opportunity to frivolously spend the inheritance.