Life insurance can be an underused part of estate planning
Recently, an unnamed Silicon Valley billionaire took out an eye-popping $201 million life insurance policy – the biggest life insurance policy ever written. While on the surface this seems excessive, in reality there was probably a very good reason for obtaining such a large policy. The billionaire has enough assets to be hit substantially with state and federal estate taxes, but much of the billionaire’s value may be tied up in a business or other illiquid assets like real estate. In order to avoid forcing beneficiaries and heirs to sell assets, maybe at a loss, the life insurance policy can cover the costs associated with executing the estate and paying taxes.
An irrevocable life insurance policy is a good way to own life insurance. Without an irrevocable trust, proceeds from life insurance are included in the decedent’s estate for estate tax purposes, because the owner of the policy can change beneficiaries and withdraw the cash value of the policy.
An irrevocable life insurance trust, on the other hand, allows for the death benefit to be excluded from the decedent’s estate. An irrevocable trust means that the grantor (the person who created the trust) cannot withdraw funds from the trust or change beneficiaries. In essence, an irrevocable trust removes all “incidents of ownership,” meaning the IRS cannot attribute the trust funds to the grantor. Upon death, the life insurance proceeds go directly to the trust for distribution to beneficiaries. Because the insurance proceeds go to the trust, not directly to a spouse, an added benefit is that the spouse’s estate will not be taxed on the death benefit either.
Granted, only a handful of people need a $201 million life insurance policy. But a federal estate tax is applied to any estate valued at or above $5,340,000 in 2014; many states, such as New York, also have an estate tax for any estate valued at or above $1 million. That means New Yorkers with a home or small business may find themselves with an estate tax despite relatively little cash compared to the value of the estate.
Estate taxes are generally substantial and must be paid in cash nine months from the decedent’s death.
Creating a thorough estate plan can save money and hassle for beneficiaries
Life insurance is valuable for people regardless of their financial situation. For those concerned about estate taxes, however, a life insurance trust can be the centerpiece of a thorough estate plan. People looking to create a will or trust should contact an experienced estate planning attorney to discuss their options.