Can Life Insurance Avoid Estate Taxes?
What is Estate planning?
In simple terms, estate planning is providing detailed direction for all money and property while living, to be carried out after dying. The vehicle for this pre-planning is called a trust. A properly planned trusts can avoid costly probate proceedings, baseless claims to property, misuse of funds, and YES even taxes. There are many types of trust that can be created, however we will focus on the main two that all types must fall under, revocable and irrevocable.
What is a Revocable Trust?
A revocable trust is a legal shelter for estate funds and property marked for specific use or delivery to another entity at the creator’s death. This type of trust allows the grantor (creator) to maintain control and direction of the proceeds as well as the right to reclaim if necessary. It is not yet deemed a gift or transfer of property until death, and therefore enjoys all the benefits of being trusted except avoidance of taxes. The key word here of course is “revoke”, meaning this can be reversed or altered by the grantor at any time. Because of the detailed direction and appointment of trustees and beneficiaries, revocable trust are often used in place of a will.
What is a Irrevocable Trust?
Naturally, a irrevocable trust is one that also enjoys all the benefits of being trusted but also alters your tax burden. Once the grantor places this money and property, all control and rights to such are relinquished. At the time of transaction a full gift is deemed to have been made. If the value placed in the trust is over the annual gift exclusion, it will be subject to gift taxes, both federal and sometimes state. The lifetime limits however to such a gift are $13.9 million federally ($18,000 annually) and $6 million in the state of Maryland. This means that any gifted amount under these lifetime and annual limits will enjoy a tax free transfer. Current estate tax rates max out at a whopping 40% federally and 10% in the state of MD on amounts over the exemptions. This translates to hundreds of thousands of dollars due, just to receive an inheritance , if due diligence was not done planning in advance of such a burden.
How does Life Insurance work with Estate Planning?
It was a long journey, but we have finally arrived at the art of reducing that burden, and this is where life insurance again earns its gold star. A annual gift exemption caps the amount of money that a grantor can actually transfer out of the taxable estate at one time as of 2024 at $18,000.00. If gifts of this amount are being made in an effort to reduce potential estate taxes, it means the estate as a whole is valued over almost $14 million dollars. In the grand scheme, one would be hard pressed to find enough family to gift enough rounds of these modest payments that actually put a dent in such a liability.
Instead of trying to gift enough money away to keep heirs from dodging the tax man, we preserve your money and multiply it by many factors, tax free. By purchasing a large life insurance policy placed in a irrevocable trust, you effectively are transferring from a taxable estate to a tax free death benefit, payable immediately to your heirs. Rather than every dollar gifted being a dollar taken, a life insurance policy will give your beneficiaries several dollars per dollar of premium. The death benefit is immediate, so instead of hoping to have enough time left as a grantor to continue gifting, your estate can immediately be covered for all and more of the assumed tax burden. Upon the grantor’s death, the tax free benefit will then provide immediate compensation to the trustee to be used as directed. Properly planned, life insurance can nullify estate taxes and even enhance the estate itself, without burdening beneficiaries.
Of course not just any policy will do, fortunately this is the type of high level life insurance planning Bay Life specializes in performing. We sincerely hope this information may be useful, even if we are not granted the opportunity to do so for you.
