Do I Have to Take Out a Life Insurance to Pay Estate Taxes?
Estate taxes affect you if your estate is valued at more than $5 million (as of 2011). The estate tax rate on estates valued at over $5 million is 35 percent. This represents a significant amount of money. To defray the cost of this tax, you should consider buying a life insurance policy.
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Types
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There are many different types of life insurance, but a permanent life insurance policy may be your best option if you intend on having the death benefit pay estate taxes. You'll need a permanent policy if you live beyond age 80 or 85 (depending on the state you live in) because these upper ages are when the government restricts or prohibits the purchase of term life insurance. A term policy is one which is in force for a set number of years. A permanent policy, like whole life insurance, variable life and universal life insurance, stays in force for your entire life.
Significance
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A permanent policy matures at your age 100 or age 120, depending on the policy type. This means that the policy pays a death benefit to you up to your age 100 or 120. If you live to age 100, the insurer offers you the option to take the death benefit in cash. But, you don't have to do this. You may instead leave the death benefit with the insurer, and the insurance company will pay the benefit to your beneficiaries when you die.
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Benefit
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The benefit of using life insurance to pay estate taxes is that you only use a small portion of your personal savings to pay for the taxes due. Additionally, you may buy enough life insurance to recoup the cost of the premiums paid on the policy. This means your entire savings is passed to your heirs intact.
Consideration
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Consider using a trust to hold the life insurance policy. A life insurance trust removes the life insurance policy from being counted in your estate when you die. This is important because, otherwise, the death benefit will be added to the value of your estate. This could result in paying higher estate taxes. The life insurance trust must be drafted by a lawyer familiar with these kinds of trust arrangements. You won't be able to alter or retain control over the policy once it is transferred into the trust. The trust should be funded with enough income when it is established to pay for the policy for the rest of your life.
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