Life Insurance ll

Providing Cash to Pay for Estate Taxes

Some seniors think that life insurance benefits are tax-free, so they purchase them to provide an inheritance for family members or others. But tax-free means only that the beneficiary does not have to pay income taxes on the proceeds that are paid after the insured person dies.

What many individuals do not realize is that life insurance can increase their estate taxes, because the often-substantial value of a life insurance policy is included in a taxable estate. Life insurance can be the asset that pushes an estate's value over the decedent's applicable exclusion amount and into a situation of owing estate taxes.

However, it is possible to exclude a life insurance policy from the taxable value of an estate by making the heirs the owners of the policy, or by creating an irrevocable life insurance trust (ILIT) with the heirs as its beneficiaries.

A properly established irrevocable life insurance trust provides an inheritance and funds to pay anticipated estate taxes. For example, it may be distasteful to some individuals to think of being forced to quickly sell a large portion of their assets in a business or real estate to pay federal estate taxes. But if they place these assets in an irrevocable life insurance trust, it allows them to pass on intact estate to their heirs without liquidating a portion of it to pay estate taxes. Also, if an individuals estate is close to or will exceed the applicable exclusion amount, it makes sense to create an irrevocable life insurance trust to remove assets from the taxable estate, assuming the policy premiums are less than paying the estate taxes.

Seniors who are considering an irrevocable life insurance trust are advised to seek guidance from an estate planning attorney who can ensure this trust is properly crafted to prevent it from being included in the decedent's taxable policy-such as the ability to borrow against cash value or change beneficiary designations-the life insurance policy will be included int eh estate. And, because the senior cannot change an irrevocable trust after it is created, it is important to carefully consider his or her future needs and goals at the time the irrevocable life insurance trust is established.

In addition, married couples can take advantage of a second-to-die (survivor) life insurance policy. This policy pays at the second death when estate taxes are due, but usually costs less than buying a separate life insurance policy for each spouse. Second-to-die life insurance policies may be available even when one spouse is un-insurable.

The information above is reprinted from Working with Seniors: Health, Financial and Social Issues with permission from Society of Certified Senior Advisors® . Copyright © 2009. All rights reserved.