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Life Insurance and Estate Taxation
l
ife insurance, which can help to
provide for your heirs in the event
of your death, can be an important
estate planning tool. It can provide
funds to loved ones when they need
it most and help meet your family’s
financial obligations. One issue overlooked by many people, however, is
that life insurance can add significant
wealth to their overall estates, potentially causing assets to exceed the
applicable exclusion amount of
$5 million in 2011, the amount that
can be sheltered from estate taxes.
Fortunately, with proper guidance, it
is possible to keep your life insurance
policy proceeds out of your estate
and also provide immediate funding
for short-term financial needs.
You may already know that the
inclusion of life insurance policy
benefits in your taxable estate is
contingent partly upon incidents of
ownership. Policy proceeds cannot
be excluded from estate taxation if
you have held any incidents of ownership in the policy during the threeyear period preceding your death.
In general, an incident of ownership is the right to exercise control
over the policy or to receive an
economic benefit from the policy,
including any powers to surrender
the policy, to pledge the policy as
collateral, or to assign the policy and
any reversionary interest equal to 5%
or more of the value of the policy
before death. Incidents of ownership
also apply to any power to act as a
fiduciary of a trust that holds insurance on your life if you established
the trust, transferred the policy or
consideration for the policy to the
trust, or could have exercised any
fiduciary power over the trust for
your own benefit. On the other hand,
your estate may not include your life
insurance proceeds merely because
you planned its purchase or gifted
money used to pay premiums within
three years prior to your death.
Again, entire policy benefits may
be included in your estate unless all
incidents of ownership are transferred
more than three years before your
death. In practice, the application of
this rule is not always clear. Therefore, it is important to consult with
your tax and legal advisors to ensure
that your actions are consistent with
your desired objectives.
Steps You Can Take
Here are some general guidelines
you may want to discuss with your
advisors. For new life insurance
policies, proceeds are not included
in the estate of the insured when
another person (often an adult child
or an irrevocable trust created by
the insured) is the initial applicant
and owner of the policy, or when the
insured never possessed an incident
of ownership in the policy.
If you want to keep life insurance
proceeds on existing policies out of
your estate, you need to transfer any
incidents of ownership in the policy
to another person at least three
years before your death. In addition,
make sure that your estate is not the
beneficiary of the policy and that the