Protecting Life Insurance from Federal Estate Tax

No one wants to lose half of the value of their life insurance to the federal estate tax.  But that is exactly what can happen if you don’t plan carefully.  You’re in luck because the federal estate tax is often a voluntary tax.  You volunteer to pay by not planning.  We suggest that you plan and avoid the federal estate tax.

• Unified Credit – Each individual can pass a certain amount during his lifetime or at death without paying federal estate tax.  This amount is called the unified credit.

• 2011 and 2012 – In these two years, the unified credit is $5,000,000 per individual.

• 2013 and beyond – Then, the unified credit returns to $1,000,000 and many families will be affected unless Congress takes action to protect families.

• Your Estate – The federal estate tax is a transfer tax on all the assets that you own at your death, including your real estate, retirement accounts, bank accounts, investment accounts, business interests, and life insurance.

• Tax Rate in 2011 and 2012 – 35% of every dollar over $5,000,000.

• Tax Rate in 2013 and beyond – More than 40% of every dollar over $1,000,000.

• The Solution – Because your estate includes everything you own at your death, you can protect the proceeds of life insurance by keeping the policy and the proceeds out of your estate.  You do this by having an Irrevocable Life Insurance Trust own the life insurance policy.

• How it Works in a Nut Shell

• Your estate planning attorney designs and drafts an irrevocable life insurance trust
• You execute the trust, and the trustee of the life insurance trust applies for life insurance on you and opens a checking account
• You make a gift to the trust by depositing money into the trust’s checking account; the trustee notifies trust beneficiaries of their right to withdraw the gift (known as Crummey notices), and uses the gift that is not withdrawn to pay life insurance premiums.
• When you die, the proceeds are out of your estate and pass in trusts to your beneficiaries.

If you have questions about how to protect life insurance proceeds from the federal estate tax, consult with a qualified estate planning attorney.