How to Reduce Estate Taxes with Life Insurance
Every day our agency receives calls from potential clients asking, “How do I reduce my estate taxes with life insurance?”
In the vast majority cases, we can help eliminate or greatly reduce your estate tax liability with life insurance.
It is vital that your life insurance policy is setup correctly though....
By assigning the wrong beneficiary to your policy or creating the wrong type of trust, you could actually increase your estate tax liability. To avoid this disaster, continue reading and we’ll show you how to correctly reduce estate taxes with life insurance.
Here’s what we'll cover in this post:
Quick Article Guide
Here’s what we'll cover in this post:
Life Insurance to Pay Estate Taxes
If your estate is worth more than the IRS’s federal estate tax exemption, your heirs will owe estate taxes on assets you leave behind. If you want your loved one's to keep all of the assets you intend to leave them, they'll probably need an influx of cash to the pay taxes on your property when you pass away.
As of 2024, the federal exemption for an individual's estate is $13.61 million. While this amount is historically high, its important to note that the federal exemption will revert back to roughly $6.8 million dollars in 2026. And, in addition to federal estate taxes, some states also impose their own inheritance and estate taxes.
Depending on the overall value of your estate, these taxes could greatly diminish the value of the assets you leave your heirs.
Currently, the federal estate tax rate is set at 40%. This means that if your estate's value exceeds $13.61 million, your loved ones will owe the IRS 40% of the value of your assets that exceed the exemption. For example, if your assets are valued at $16 million, your heirs would owe $956,000 in estate taxes.
Total Estate Value = $16,000,000 - $13,610,000 (Federal Exemption)Value of Estate Excceding Exemption = $2,390,000Estate Tax Liability = 40% of $2,390,00 = $956,000
In some states, your heirs will be subject to an estate or inheritance tax, even if your assets do not exceed the federal exemption for the current year. For example, in Oregon estates worth more than $1 million are subject to a tax rate of at least 10%. After providing my clients with this explanation, their next question is almost always:
“How do I avoid having my heirs owing estate taxes on the death proceeds of my life insurance policy?”
Estate Taxes on Life Insurance Death Benefits
One of the most common mistakes we see with estate planning life insurance purchased for estate planning is naming the wrong beneficiary. If your life insurance was purchased for estate planning, you'll need to make sure your beneficiary isn't an immediate family member or your estate.
Leaving assets such as life insurance policies or annuities to your estate or family members can increase your estate’s value, leaving your heirs with an unexpected tax liability. If you listing your estate as the beneficiary, you'll lose the contractual advantage of naming a real person or a trust, and subject your life insurance proceeds to the timely and costly probate process.
The money to settle your estate taxes with the IRS must be paid by your heirs within nine months of your passing.Your beneficiaries cannot afford delays due to the courts or court procedures.
According to Section 2042 of the Internal Revenue Service Tax code states that the proceeds of your life insurance policy will be added to the gross value of your estate if the proceeds are paid to your estate whether it’s directly or indirectly, or if you possessed any incidents of ownership of the policy at the time of your death.
In the eyes of the Internal Revenue Service incidents of ownership include;
- Having the ability to cancel or surrender the policy.
- Being able to change the beneficiary or beneficiaries.
- Having the ability to borrow cash that the policy has accrued.
- Having the ability to choose the payment method of the proceeds to the beneficiaries. (Installment payments or lump sum)
When creating an irrevocable life insurance trust, we usually recommend utilizing a trust/estate attorney or an executive from your bank. If you're having troubles deciding where to go or how to start the process, give us a call and one of our agents will be happy to help walk you through the process.
We specialize in educating our clients on how to reduce estate taxes with life insurance and we have helped hundreds of clients just like you. However, its important to note that we are not tax attorneys and our agents cannot provide legal advice.
Creating an Irrevocable Life Insurance Trust
The best way to prevent your heirs from paying estate taxes on the proceeds of your life insurance is to create an Irrevocable Life Insurance Trust or “ILIT.”
However, you cannot be the trustee of the trust, and you cannot retain any rights to revoke the trust. The policy is held by the trust, which means that you will no longer be the listed owner, therefore proceeds will not be considered as part of your estate.Although creating an Irrevocable Life Insurance Trust is a complicated process in which you normally need to involve an attorney, banker, and a life insurance agent; they’re the best way for you to retain control over your policy, ensuring that the premiums are paid and the death benefit is exempt from estate taxes.
When you create an ILIT, the trust owns the policy and the trustee must follow the instructions that you specify for the assets that are to be disbursed. Another benefit of creating an “ILIT” is that the proceeds stay in the trust; protecting the proceeds from courts, creditors, spouses, and irresponsible spending.
If you name an individual as the sole beneficiary of your life insurance policy, and that person has been diagnosed with an intellectual disability when you die, the courts can take control of your policy's death benefit. Possibility preventing the money from being used the way you intended.
Most life insurance companies will not pay the death benefit from your policy to anyone that is has been diagnosed with an intellectual disability, and they'll usually demand court supervision. If you set an up in Irrevocable Life Insurance Trust, you can avoid the court process known as “probate.”
This will allow your trustee to immediately allocate the correct share of your estate towards the personal care of your incapacitated relative after you pass away. ILIT’s are also used to establish a special needs trust. To learn more about these types of trusts, please read our article; “Establishing a Trust for A Special Needs Child.”
What’s the Best Age to Create an Irrevocable Life Insurance Trust?
Most people wait until their 50’s or 60’s to set up an Irrevocable Life Insurance Trust. By the time you reach this age; family relationships are usually settled, children have moved out, and retirement is on the horizon. Don’t worry about getting into the game a little later in life, usually we can offer coverage until age 80.
However; it’s important not to wait too long in the case you become uninsurable. Remember, the younger you are when lock in your rates,the more you'll save in the long run. For this reason, we recommend buying permanent life insurance permanent coverage to protect your estate as soon as you realize you need it.
While we are experts at life insurance, we are not estate planning attorneys. Most attorneys will recommend executing a trust document with an independent trustee, opening a bank account in the name of the trust, and obtaining a tax identification number for the trust to get started.
Once your irrevocable life insurance trust has been created, you can give us a call at 855-247-9555, and we'll start the application process. Most permanent life insurance policies take 6 to 8 weeks for approval.
While term life insurance policies work well for most situations, we always recommend a permanent life insurance policy for your estate planning needs. You do not want to risk outliving your life insurance policy if you want your heirs to avoid an estate tax liability on the assets you intend to leave behind.
The best life insurance policy for estate protection is called a guaranteed universal life insurance policy. These policies offer affordable coverage with fixed rates until the age of 90, 95, 100, 110, or 121. Guaranteed Universal Life insurance works just like a term policy, but it offers guarantees until later in life.
Avoid Term Life Insurance when Estate Planning
When you are ready to purchase the coverage you need, avoid the big-box term life insurance companies that you see advertised on television. Most banks and attorneys will turn away someone who wants to create an irrevocable trust with term life insurance.
Term life insurance policies usually expire by the age of 80, and your attorney does not want to deal with the liability of you outliving your life insurance policy. If you're purchasing a life insurance policy for estate protection, you'll want to lock-in and guarantee your coverage until you reach the age of 90 or later. In fact, with increasing lifetime expectancy, most experienced trust attorneys will recommend purchasing a policy that is guaranteed until age 110 or 121.
Like any other product, when purchasing a permanent life insurance, shop the market to make sure purchase the best policy at the lowest rate. Being diligent and choosing the right company will save you thousands of dollars over your lifetime. No matter what your life insurance needs are, we're happy to help.
JRC is appointed with 63 highly-rated life insurance companies and we'll shop the market to match you with the best option available. We’re also an owner operated company so customer service is our number one priority. Give us a call today at 855-247-9555 or request a free quote below.
Managing Partner and Co-founder
Cliff is a licensed life insurance agent and one of the owners of JRC Insurance Group. He has helped thousands of families of businesses with their life insurance needs since 2012 and specializes with applicants who are less than perfect health. In his spare time he enjoys spending time with family, traveling, and the great outdoors.