Avoid Tax on Life Insurance

Dear Friends,

Do you own your life insurance policy? If so, you could be asking for tax trouble. Reason: The proceeds from the policy will be included in your taxable estate.

However, you can avoid potential problems by establishing a life insurance trust and transferring ownership of the policy to the trust. Accordingly, the life insurance proceeds are removed from your estate, perhaps saving your family tens or even hundreds of thousands of tax dollars.

This technique is typically used for an existing life insurance policy, but it also works if you have the trust purchase a new policy on your life (or the lives of you and your spouse).

Background: Generally speaking, life insurance proceeds are exempt from federal estate tax. However, if an individual possesses any “incidents of ownership”‘ — for instance, he or she owns the policy or reserves the right to change beneficiaries or borrow against the policy — the proceeds are included in the individual’s taxable estate.

However, if a life insurance trust owns the policy, the death benefits are kept out of your taxable estate. Also, a properly structured trust can keep the money away from spendthrift children and their disgruntled spouses. And the insurance money can be used to cover any other estate tax liability, leaving other assets intact for the family.

To shelter your estate from tax, a life insurance trust must be irrevocable. In other words, you can’t change your mind once you put it in place. Because you’re the insured individual, you can’t act as the trustee, either. Instead, you may name your child or children as trustees (or a bank or professional advisor). This gives your children control over the policy without the risks of direct ownership. As the owner of the life insurance policy, the trust pays the premiums. When the insured person passes away, the trust collects the proceeds, estate tax-free.

This is a complex area of the law and generally requires professional assistance.  Contact my office at 303 447 1626 to schedule a meeting to discuss your particulars.