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The Strategic Use of Life Insurance in Estate Tax Planning

Life insurance is not just a financial safeguard for beneficiaries. It is also a pivotal tool in minimizing estate tax liabilities in comprehensive estate planning, especially for high-net-worth individuals. Because of the dual functionality of life insurance, it is critical to consult an attorney about how to use it strategically to achieve your goals.

Understanding the Complexities

A potent strategy for integrating life insurance into estate planning is through the establishment of an Irrevocable Life Insurance Trust (ILIT). By placing a life insurance policy within an ILIT, the proceeds are excluded from the taxable estate. This setup is essential because, although life insurance proceeds are generally exempt from income tax, they can still inflate the estate's value if the policyholder retains incidents of ownership. Such incidents include rights to change beneficiaries, borrow against the policy, or alter terms. When an ILIT owns the policy, these rights are relinquished, ensuring the policy's proceeds do not increase the estate's value and subsequently reduce potential estate tax exposure.

However, cross-jurisdictional issues add a layer of complexity. For estates that span multiple jurisdictions, each may have different rules about taxing life insurance proceeds. Strategic placement of life insurance policies, therefore, requires a meticulous analysis of the laws in each applicable jurisdiction to ensure optimal tax outcomes. Moreover, life insurance can address issues with the Generation-Skipping Transfer Tax (GSTT), which is imposed on transfers to grandchildren exceeding certain thresholds. Allocating life insurance proceeds via an ILIT directly to grandchildren avoids GSTT, as the trust can be designed to be exempt from such taxes.

Another creative but often overlooked strategy involves using annual gift tax exclusions to pay life insurance premiums. Individuals can gift up to $18,000 per year, as of 2024, per recipient without incurring a gift tax, which can be strategically used to fund premium payments on a life insurance policy held within an ILIT. This approach allows substantial funding of life insurance policies without reducing the estate's size or triggering additional gift taxes.

Once your ILIT is established, utilize the annual gift exclusions to fund the premiums. This maximizes financial benefits while minimizing your taxable estate's impact.

By carefully integrating life insurance into your estate planning, you can significantly enhance the financial security of your beneficiaries while strategically reducing your estate’s tax liabilities. This approach not only provides for your heirs but also ensures that your legacy is passed on efficiently and according to your wishes.

If you have questions about how to best utilize life insurance or want to discuss your estate plan, give us a call at (516) 570-4016.