Life insurance, which can help to provide for your
heirs in the event of your death, can be an important
estate planning tool. It can provide funds to loved
ones when they need it most and help meet your
family’s financial obligations.
One issue overlooked by many people, however, is
that life insurance can add significant wealth to an
overall estate, potentially causing assets to exceed
the 2021 applicable exclusion amount of $11.7 million
(per individual), the amount that can be sheltered
from estate taxes. Fortunately, with proper guidance,
it is possible to keep your life insurance policy
proceeds out of your estate and to also provide
immediate funding for short-term financial needs.
Know the rules
You may already know that the inclusion of life
insurance policy benefits in your taxable estate is
contingent partly on incidents of ownership. Policy
proceeds cannot be excluded from estate taxation if
you have held any incidents of ownership on the
policy during the three-year period preceding your
In general terms, an incident of ownership is the right
to exercise control over the policy or to receive an
economic benefit from the policy, including any
powers to surrender the policy, to pledge the policy as
collateral, or to assign the policy and any reversionary
interest equal to 5% or more of the value of the policy
before death. An incident of ownership also exists on
a policy if you have any power to act as a fiduciary of
a trust that holds insurance on your life if you
established the trust, if you transferred the policy or
consideration for the policy to the trust, or if you could
have exercised any fiduciary power over the trust for
your own benefit. However, your estate may not
include your life insurance proceeds merely because
you planned to purchase the insurance or gifted
money used to pay premiums within three years prior
to your death.
Again, entire policy benefits may be included in your
estate unless all incidents of ownership are
transferred more than three years before your death.
In practice, the application of this rule is not always
clear. Therefore, it is important to consult with your
tax and legal advisors to ensure that your actions are
consistent with your desired objectives.
A plan of action
Here is some additional information that you may
want to discuss in detail with your advisor: for new life
insurance policies, insurance proceeds are not
included in the estate of the insured when another
person (often an adult child or an irrevocable trust
created by the insured) is the initial applicant on, and
owner of, the policy, or when the insured never
possessed an incident of ownership on the policy.
If you want to keep life insurance proceeds on
existing policies out of your estate, you need to
transfer any incidents of ownership on the policy to
another person at least three years before your death.
In addition, make sure that your estate is not the
beneficiary of the policy and that the policy beneficiary
is not required to use policy proceeds to pay estate
claims and expenses.
Keep the above in mind as you develop a plan for
keeping your life insurance proceeds out of your
estate. Remember, before you take any action that
might affect your policies, consider carefully all of the
alternatives and seek professional counsel on how to
best achieve your specific objectives.
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