Life insurance, which can 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 often overlooked, however, is that life insurance can add significant wealth to an overall estate, potentially causing assets to exceed the 2021 applicable exclusion amount of $11.7 million (per individual), 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 to also provide immediate funding for short-term financial needs.
Know the Rules
You may already know that the inclusion of life insurance policy benefits in your taxable estate is contingent partly on incidents of ownership. Policy proceeds cannot be excluded from estate taxation if you have held any incidents of ownership on the policy during the three-year period preceding your death.
In general terms, 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. An incident of ownership also exists on a policy if you have any power to act as a fiduciary of a trust that holds insurance on your life if you established the trust, if you transferred the policy or consideration for the policy to the trust, or if you could have exercised any fiduciary power over the trust for your own benefit. However, your estate may not include your life insurance proceeds merely because you planned to purchase the insurance or gifted money used to pay premiums within three years prior to your death.
...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.
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.
A Plan of Action
Here is some additional information that you may want to discuss in detail with your advisor: for new life insurance policies, insurance 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 on, and owner of, the policy, or when the insured never possessed an incident of ownership on 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 on 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 policy beneficiary is not required to use policy proceeds to pay estate claims and expenses.
Keep the above in mind as you develop a plan for keeping your life insurance proceeds out of your estate. Remember, before you take any action that might affect your policies, consider carefully all of the alternatives and seek professional counsel on how to best achieve your specific objectives.
Our financial advisor, Dallas Lee Whittaker, is here to help you manage your finances and achieve your goals.
Dallas Lee Whittaker CMFC, CLU
Senior Vice President
Dallas has over 20 years of experience in all areas of wealth management and financial services. He is passionate about adding value to the lives of his clients through education and addressing their financial goals in a collaborative manner. With a deep knowledge of insurance which is an added benefit when doing financial planning, Dallas is an asset to our clients and the Marine Bank Wealth Management team.
Dallas currently holds a Chartered Mutual Fund Counselor (CMFC) designation awarded through the College for Financial Planning and a Chartered Life Underwriter (CLU) designation through the American College. As Senior Vice President of the Marine Bank Wealth Management Department, Dallas focuses on comprehensive financial planning to help individuals and businesses achieve peace of mind in their financial lives with an emphasis on retirement strategies, legacy planning, and generational wealth management.
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