How to Use Life Insurance to Pay Estate Taxes

If a couple's estate is in the millions, more of that estate may go to the Federal Government in taxes than to heirs. Leverage tax payments with life insurance.

Difficulty:

Challenging

Instructions

Things You'll Need

• Financial Manager
• Insurance
• Legal Services
• Life Insurance
• Tax Consultants
• Tax Services
• Whole Life Insurance
• Personal Financial Software
• Tax Preparation Software

1. Create a team for estate planning purposes that consists of an attorney, accountant, and financial professional, all experienced in generational wealth transfer and its tax consequences.

2. Coordinate the production of a comprehensive financial plan for your immediate family, which includes retirement income for you and your spouse, considerations for the surviving spouse, and the systematic transfer of assets to the next generation(s).

3. Focus on the projected estate value at the estimated life expectancy of the surviving spouse.

4. Exhaust all prudent strategies for reducing that projected value with each of your team members.

5. Create an Irrevocable Life Insurance Trust (ILIT).

6. Consider changing ownership of any existing cash-value life insurance policies to the ILIT to remove their death benefits from the taxable estate.

7. Apply for a life insurance policy in the amount of projected estate taxes at the death of the surviving spouse ("second-to-die"), making the ILIT the owner and beneficiary of the policy.

8. Make an annual tax-exempt "gift" to the ILIT, the trustee of which will then make an annual premium payment for the insurance policy.

9. Pay estate taxes at the death of the second spouse with the income tax-free death benefit of the life insurance policy, which should be many times greater than the sum of the premiums paid.

Tips & Warnings

• The agreement of all team members will give your plan for using life insurance to pay for estate taxes the greatest chance of success.

• Pay close attention to any newly legislated tax laws that might effect your plan.

• Premiums for one insurance policy on two lives are cheaper than two, single-life policies, even if one of the two lives is "uninsurable".

• The death benefit of life insurance policies can be adjusted downward if tax laws result in lower future estate taxes.

• Consider life insurance policies with an increasing death benefit if you are concerned about keeping up with a growing estate.

• Apply only for a permanent type of insurance policy, unless the estate tax liability is projected to last only for a specified number of years (rare).

• For large death benefits (over $5,000,000) consider dividing the coverage over two or more insurance companies.

• Apply to more than one company, regardless of the amount, and choose only companies rated A+ or better by AM Best.

• "Irrevocable" means just that - once created and funded, all assets in the ILIT are permanently removed from the estate.

• Applications for large death benefits require extensive medical and financial underwriting, and can take months before a decision is made by the companies.

• The insurance companies will want to see a full copy of the ILIT agreement before they issue a policy.

• Professional costs for your team may be high; shop around, but demand quality.

• A comprehensive financial plan can cost from the low hundreds up to several thousand dollars.

• Avoid estate planning seminar teams that offer low-cost deals unless you have thoroughly checked out their credentials with state and national licensing and registration agencies.