Today’s federal estate tax exemption is so generous that only a handful of ultra-high-net-worth families are subject to tax at a rate as high as 40 percent. This is set to change in 2026 when the amount taxpayers may exclude from estate tax is scheduled to be cut in half and reduced to approximately $6 million for individuals or $12 million for married couples filing joint returns. The good news is there are many strategies you can employ to hedge against the lower exemption and shield your heirs from having to pay estate taxes on the proceeds from your insurance policy.
Your beneficiaries generally are not subject to income tax on the payout from your life insurance policy upon your death. However, there are times when insurance proceeds can be included in your taxable estate and subject to federal and state estate taxes, such as when you are the life insurance policy owner or your estate is named as a beneficiary of the policy’s death benefits. To avoid this scenario, you may instead create an irrevocable life insurance trust (ILIT) to hold your insurance policies.
By putting life insurance policies into an ILIT, you transfer policy ownership to the trust, pay the policy premiums with trust assets and name the trust as the beneficiary to receive the insurance proceeds. Upon your death, these payouts pass to the trust outside your taxable estate and are overseen by an independent, unrelated trustee (other than the insured) you name to manage distributions to your beneficiaries free of income tax liabilities and according to your post-mortem wishes. When the ILIT contains a permanent life insurance policy with a cash value, you remove the policy’s cash value from your taxable estate as well and allow the investment portion of the policy to grow free of income and estate tax implications. This enables you to direct a portion of the death benefit to cover any estate tax liabilities you may have on non-trust assets valued above the federal exemption amount, saving your heirs from the difficult task of selling appreciated assets or spending down their inheritances.
Despite these unique benefits, ILITs have some rules and challenges that may inadvertently trigger adverse tax consequences for unwary individuals. For example, transferring an existing policy into an ILIT may have gift tax consequences, and death benefits paid out less than three years after you transfer a life insurance policy into an ILIT do not escape estate tax. Planning under the guidance of experienced financial advisors can help avoid these traps.
About the Author: Scott Montgomery is a director and financial planner with Provenance Wealth Advisors (PWA), an Independent Registered Investment Advisor affiliated with Berkowitz Pollack Brant Advisors + CPAs and a registered representative with PWA Securities, LLC. He can be reached at the firm’s Ft. Lauderdale, Fla. office at (954) 712-8888 or info@provwealth.com.
Provenance Wealth Advisors (PWA), 200 E. Las Olas Blvd., 19th Floor, Ft. Lauderdale, Fla. 33301 (954) 712-8888.
Scott Montgomery is a registered representative of and offers securities through PWA Securities, LLC, Member FINRA/SIPC
This material is being provided for information purposes only and is not a complete description or a recommendation. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. There is no guarantee that these statements, opinions or forecasts provided herein will prove correct.
Any opinions are those of the advisors of PWA and not necessarily those of PWA Securities, LLC. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of PWAS, we are not qualified to render advice on tax or legal matters. You should discuss any tax or legal matters with the appropriate professional. Prior to making any investment decision, please consult your financial advisor about your individual situation.
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Posted on September 3, 2024