| Estate & Gift Tax / Keeping life insurance out of your estate |  |
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This is an important issue because,
once the federal estate tax applies, the rates are high (beginning at
37% and going up to 55%). Insurance on your life will be
included in your taxable estate if either: (1) Your estate is the beneficiary
of the insurance proceeds, or (2) You possessed certain economic
ownership rights ("incidents of ownership") in the policy at
your death (or within three years of your death). Avoiding the first situation is
easy: just make sure your estate is not designated as beneficiary of the
policy. The second rule is more complex.
Clearly, if you are the owner of the policy, the proceeds are included
in your estate regardless of who the beneficiary is. However, simply
having someone else possess legal title to the policy will not prevent
this result if you keep so-called "incidents of ownership" in
the policy. Rights that, if held by you, will cause the proceeds to be
taxed in your estate include: . . . the right to change
beneficiaries, . . . the right to assign the policy
(or to revoke an assignment), . . . the right to pledge the policy
as security for a loan, . . . the right to borrow against
the policy's cash surrender value, and . . . the right to surrender or
cancel the policy Keep in mind that merely having
any of the above powers will cause the proceeds to be taxed in your
estate even if you never exercise the power. Buy-sell agreements.
Life insurance obtained to fund a buy-sell agreement for a business
interest under a "cross-purchase" arrangement will not be
taxed in your estate (unless the estate is named as beneficiary). For
example, say Al and Bob are partners who agree that the partnership
interest of the first of them to die will be bought by the surviving
partner. To fund these obligations, Al buys a life insurance policy on
Bob's life. Al pays all the premiums, retains all incidents of
ownership, and names himself beneficiary. Bob does the same regarding
Al. When the first partner dies, the insurance proceeds are not taxed in
his estate. Life insurance trusts.
A life insurance trust is an effective vehicle that can be set up to
keep life insurance proceeds from being taxed in the insured's estate.
Typically, the policy is transferred to the trust along with assets that
can be used to pay future premiums. Alternatively, the trust buys the
insurance itself with funds contributed by the insured. As long as the
trust agreement gives the insured none of the ownership rights described
above, the proceeds will not be included in his estate. The three-year rule. If you are considering setting up a life insurance trust with a policy you own currently or simply assigning away your ownership rights in such a policy, please call me as soon as you reasonably can to effect these moves. Unless you live for at least three years after these steps are taken, the proceeds will be taxed in your estate. For policies in which you never held incidents of ownership, the three-year rule doesn't apply. |
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