How to use life insurance to pay inheritance tax

With the 2022 federal estate tax exemption amount at $12.06 million ($24.12 million for a married couple), it may seem unlikely that your heirs will have to pay taxes. on estates under current tax law. However, this law is set to expire at the end of 2025, with the exemption amounting to an inflation-adjusted amount of approximately $6.2 million ($12.4 million for a married couple). Unless Congress votes to extend the higher amount of the estate tax exemption, many more Americans are at risk of having their estates subject to tax. At a tax rate of 40%, this can mean that a substantial amount goes to the Internal Revenue Service (IRS) instead of loved ones. Additionally, your state may also have an estate tax. State exemption amounts are often lower than the federal amount, so your state of residence could also collect considerable taxes upon your death.

An estate planning tool in particular can be used to pay all or part of estate taxes when a large portion of the estate consists of physical assets such as real estate, art, jewelry, collectibles, etc If your goal is to keep these tangible assets in the family, life insurance held by an irrevocable life insurance trust (ILIT) can be used to pay inheritance tax, so the assets do not have need to be sold.

An ILIT is a type of trust that is funded during your lifetime with 1 or more life insurance policies. It is irrevocable, which means that once you create an ILIT, the trust generally cannot be changed or revoked. In exchange for transferring your life insurance policy to an ILIT, there are several benefits: You can avoid having the death benefit of the life insurance policy included in your estate for federal tax purposes on successions; fund the trust with life insurance to help provide the cash needed to cover property taxes and other expenses after your death; and finally, having the ability to direct, through the trust deed, how and when the death benefit is used and for whom.

However, it is important to remember that this is an irrevocable trust. Once you transfer an existing policy into the trust or purchase new life insurance using the trust, you must waive any rights to make changes to the policy or trust. If you retain rights to the policy, such as the ability to withdraw cash value, the IRS and state tax authorities will still consider you to have “ownership incidents” and require the policy to be included in your succession. Therefore, you must select someone else, such as a spouse, sibling, adult child, or attorney, to be the trustee of ILIT. The trustee would then oversee the maintenance of the policies held in the ILIT, and the life insurance would no longer be part of your estate.

To pay premiums for life insurance policies, you transfer money to ILIT and the trust pays the premiums. However, you must consider gift tax. Putting money into a trust that someone else will benefit from can be considered a gift. If the premium payment for each beneficiary exceeds the gift tax exemption of $16,000 per year, gift taxes may be due.

One way to avoid this is to have the trustee send beneficiaries a “Crummey letter” each time you transfer money to the trust. This letter would advise them that they can claim their share of the money deposited within a specific time frame. If they have an immediate right to the money, gift tax does not apply. However, your beneficiaries would be foolish to withdraw the money, because without it the insurance premiums would go unpaid and the policy would lapse. The eventual payout of the life insurance death benefit would far exceed the amount expected to pay the premiums.

If you have an existing policy and transfer it to ILIT, the IRS will still consider it part of your estate if you die within the next 3 years. (This does not apply to policies purchased by the trust.) With the existing estate tax law set to expire at the end of 2025, we are approaching an alignment between the expiry of the tax law and the period 3 year waiting period for life insurance. end of transfers to ILIT. Depending on age and expected life expectancy, this calendar may be of some significance to you.

Determining whether you are at risk of paying estate taxes and whether an ILIT makes sense for you will likely require coordination between your accountant, financial advisor and estate planning attorney. Due to the irrevocable nature of ILITs, all aspects of your financial life should be carefully considered.

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As of June 21, 2005, new Internal Revenue Service regulations require certain types of written notices to include a disclaimer. To the extent that the foregoing message contains written advice relating to a federal tax matter, the written advice is not intended or written for use, and may not be used by the recipient or any other taxpayer, for the purpose of to avoid federal tax penalties, and is not written to support the promotion or marketing of the transaction or the matters discussed herein.

The information contained in this report is provided for informational purposes only. All calculations have been made using techniques which we believe to be reliable but are not guaranteed. Please contact your tax advisor to review this information and consult with them regarding any questions you may have regarding this communication.

MEDIQUS Asset Advisors, Inc. does not provide tax, legal or accounting advice. This document has been prepared for informational purposes only and is not intended to provide, and should not be relied upon for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.

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