While benefits received from a life insurance policy are not treated as income for tax purposes, if the life insurance policy is owned by the deceased within three years of his or her death, the deceased’s estate will be taxed on the amount of the insurance proceeds. above the property tax threshold. Okay, now in plain English. If you take out a life insurance policy for your own life, fund the policy for the rest of your life, and pass the proceeds on to your spouse or other family members, they will owe you a large time tax. So what can you do to avoid this?
Creating an Irrevocable Life Insurance Trust (or “ILIT”) will protect your family from the burden of land tax upon receiving the benefits of a life insurance policy. These property tax savings can be achieved either by the insured establishing an ILIT and providing the trustee with an existing life insurance policy, or by the trust itself purchasing a new policy over the insured’s life. Insurance will be removed from the insured’s property because the insured will not have a policy at the time of death.
There are three conditions: (1) the insured must not own or retain any incident of ownership in the insurance, (2) the proceeds must be paid to the trust and not to the estate, and (3) if the policy is granted by the insured. For trust, the insured must last the prize with 3 years. To avoid the consequences of gift tax, simply borrow against an existing life insurance policy for the amount of equity/value the policy has achieved since it was instituted.
ILIT also provides the benefit of instructing who gets the money, at what age they get the money, and under what conditions they can get the money. For example, you don’t want your 7-year-old to inherit $2 million at a time. How much candy and video games do they need? Instead, the ILIT can appoint a guardian and pay for the child’s needs until the child reaches the appropriate age for inheritance, such as 18, 21, or 25. You can see that your child is being cared for but not given the opportunity to squander the inheritance.
