Estate Taxes on Life Insurance

In the United States and many other countries, the government places a tax on estate that is passed down after one’s death. Here it is typically referred to as an estate tax. Though it has been in affect for many years, estate taxes have come under intense scrutiny in the United States. Many people find estate taxes unnecessary and unfair, going as far as to call them “death taxes.” While the case for this type of tax is certainly debatable, it’s important to keep in mind that it only applies to the wealthiest two percent of people. It doesn’t affect the average American and getting rid of estate taxes would probably only lead to more taxes placed on people in lower income brackets. However, if you happen to fall in that two percent of people that have to pay estate tax, you may be looking for a way to avoid it and you may be in luck.

Avoid Using Life Insurance to Pay Estate Taxes

The most common way people try to avoid estate taxes, or at least take the sting out of paying for them, is by purchasing life insurance through an ILIT, Irrevocable Life Insurance Tax. Enough life insurance is purchased to cover the estate taxes so that the beneficiary basically gets the estate tax-free. However, there is another solution that some people have had success with it, referred to as the “three inheritance” solution. Using this method, the life insurance goes to the beneficiaries instead of toward paying off estate taxes. Life insurance can be estate tax free if properly set up by an attorney in an ILIT. Then the balance of the estate is placed in a CLT or Charitable Lead Trust, where the interest on the principal amount is given to a charity for a set amount of years. When the trust is up, the principal goes back to the beneficiary, estate tax and income tax free. The three inheritances can be seen here:

1. Life insurance inheritance
2. Interest on the principal to a charity or foundation through the CLT
3. The principal back to the beneficiaries after the CLT is finished

As you can see, this method allows the beneficiaries to get the inheritance without paying any estate taxes and it allows them to make a worthy contribution to society through the charitable lead trust. Talk to your financial advisor about using the “three inheritance” solution so your beneficiaries can avoid paying estate taxes.

Additional Resources:

• Three Tips to Reduce the Burden of the Estate Tax
• Life Insurance: Too Much, Too Little or Just Right?