Thought Leaders: Life Insurance and Estate Tax

By Corey Moore - Otis and Bedingfield, LLC — 

How do the proceeds of a life insurance policy impact the value of a deceased individual’s estate?

Surprising to many clients, the proceeds of a life insurance policy are included in a deceased individual’s estate if the individual maintains any “incidents of ownership” over the policy.  There are various aspects of a life insurance policy which may cause incidents of ownership, the most common being the right to change beneficiaries.

Consequently, most individuals who acquire life insurance with the intent of protecting family members in the event of their death, maintain ownership of the policy. 

The inclusion of such proceeds may significantly impact the taxability of a deceased individual’s estate.  If the deceased individual’s estate approaches or exceeds the estate tax exemption (currently $12 million per person), in part due to significant life insurance policies, an irrevocable life insurance trust (“ILIT”) may provide significant saving. 

Upon establishing the ILIT, ownership of the policy is transferred to the trust, removing ownership from the individual.  Upon death, the proceeds of the life insurance are paid to the ILIT and thus, are not included in the gross estate of the deceased individual. 

The ILIT can then pay the policy proceeds to the deceased individual’s family or in any other manner as stated in the trust document.  Using an ILIT will decrease the value of an estate and may potentially avoid or at least minimize estate tax liability, which is currently 40% of an estate value in excess of
$12 million.