Yes, Life
Insurance is Taxable
If you believe your beneficiaries will
receive your life insurance tax-free, you may be in for a
surprise. Insurance proceeds are free from income tax but
not estate tax. The value of a business and the related
insurance that is used to fund most buy-sell agreements
cause many surprised people to realize that they may indeed
be subject to estate tax. If your estate is greater than
$675,000, there may be tax due at your death, with rates as
high as 55%.
A very simple estate planning technique to remove insurance
proceeds from taxability is the use of an irrevocable life
insurance trust. Very basically, a trust that you create
will be established to actually own the insurance policy.
You give the trust each year the amount of the insurance
premium that is due on the policy and a trustee that you
name then writes a check to pay the premium. At your death,
the insurance comes into the trust and is distributed to
the beneficiaries of the trust. This money is not included
in your estate. The beneficiaries then use that money as
needed to pay any estate tax that may be due. Assuming that
the beneficiaries of your life insurance trust are also the
main heirs of your estate, this is simply moving money into
their pocket through a different channel. On a $400,000
life insurance policy, this may save your heirs from
writing a check to Uncle Sam for close to $200,000.
With a public outcry over the steep rates of tax on
estates, Congress raised the exemption, currently at
$675,000 to $1,000,000 in the year 2006. Think you can
relax then and not properly plan? If your estate is
currently at $675,000 and grows at 8% per year it will be
almost $1,100,000 in the year 2006.
The largest asset in many estates is life insurance. By
removing this from your estate, it may keep your
beneficiaries from paying estate tax.
Drayton R. Honeycutt, CPA
