Transfer Your Life Insurance and Decrease Your Estate Tax

If you don't own your life insurance policy, it's not part of your taxable estate.

First things first: I fully expect Congress will reinstate the Estate Tax starting in 2011. Once back on the books the estate tax will affect people who die leaving a taxable estate of more than a million dollars.

Now most people laugh when asked if they are aware of Estate Tax considerations. Surely they don't have that kind of money. But you might be surprised what is included...

• Stocks and bonds
• Real estate and property
• Business interests
• Cash, savings, and checking accounts
• Annuities
• Qualified retirement plan accounts such as 401(k)s and profit-sharing plans
• Life insurance proceeds owned by the deceased

But...a modest estate, seemingly below the taxable minimum of a million dollars can easily leap well past that point in size when insurance policy proceeds are counted.

Note that all property that you leave to your spouse, including insurance proceeds, is not subject to estate taxes when you die. But if you are single or your spouse predeceased you, your life insurance proceeds would be taxed as part of your estate if the beneficiaries of the policy are your children, friends, or relatives.

Whether or not life insurance proceeds are included in the taxable estate depends on who owns the policy when the insured person dies. If the deceased person owned the policy, the full amount of the proceeds are included in the federal taxable estate; if someone else owned the policy, the proceeds are not included.

It follows that if you want your life insurance proceeds to avoid federal estate tax, you may wish to transfer ownership of your life insurance policy to another person or entity. There are two ways to do it. You can transfer ownership of your policy to any other adult, including the policy beneficiary. Or, you can create an irrevocable life insurance trust, and transfer ownership to it. In any event it is best to consult with your attorney and accountant.

Example: Mary is a widow with two adult children who are her beneficiaries. She lives in a modest home that has been paid off for years. The current value is $250K. She also has $100K in an individual retirement account she inherited from her late husband. Several years ago she purchased a $100K annuity to provide an income stream to supplement her social security. Mary has some mutual funds worth $50K. Three certificates of deposit worth $10K each, and she owns a life insurance policy with a face amount of $500K. The life insurance policy was intended to provide money for Mary's three grandchildren. Guess what? Mary's children will owe Estate Tax. If someone else owned the life insurance policy then no Estate Tax would be due.

As always, consult with your tax and legal advisor before making these estate decisions.