RETIREMENT TIPS: Life Insurance and Your Estate Plan

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AlanKondo-238x300By ALAN KONDO, CFP, CLU

Managed wisely, life insurance can be an effective component of an estate planning strategy.¹ Under the IRS’ Unlimited Marital Deduction provision, assets may pass free of estate tax from one spouse to another — provided he or she is a U.S. citizen — no matter what the amount.

But if your beneficiary is someone other than your spouse (a child, for example), he or she could inherit a hefty estate tax bill. While the IRS allows up to $5.34 million to pass to heirs free from federal estate tax in 2014, any amount above that could be taxed at a rate of up to 40%.

With an exemption that sizeable, you may not be concerned about estate taxes. But if much of your estate is illiquid — that is, if much of it is held in real estate or a business — then you may want to consider setting aside assets held outside of your estate to cover the estate tax bill. Life insurance may help you to pay estate taxes while preserving more of your wealth for future generations.

The Tax Facts

As long as you don’t own the life insurance policy and did not retain control over it within the last three years of your life, the proceeds generally will not be treated as part of your estate and therefore will not be subject to estate tax.

One strategy for capitalizing on the tax benefits of life insurance is to establish an Irrevocable Life Insurance Trust (ILIT), which serves as both owner and beneficiary of a life insurance policy. A trust can help keep the proceeds of the policy out of your estate, thus avoiding federal estate tax. In addition, when setting up the trust you can name one or several beneficiaries, or trustees. Trustees can use the proceeds of the policy to pay estate taxes and estate settlement costs, while the remaining monies, if any, can be distributed to beneficiaries free of income tax.

If you already own a life insurance policy that that is included in your estate, you may be able to gift the policy to a beneficiary. If, however, the cash value of the policy on the date of transfer is more than the $14,000 gift exclusion allowed per individual, per year (in 2014), the transfer may be subject to gift tax. It may be possible to circumvent the gift tax by naming more than one beneficiary. This would allow you to potentially transfer up to $14,000 per beneficiary without incurring gift taxes.

Devise a Plan That’s Right for You

Life insurance is just one of the many tools that could be used to help you pass your estate on to your loved ones effectively. Your Certified Financial Planner™, CPA, and/or estate planning attorney can help you evaluate your situation and assess which tools and strategies may be appropriate for your needs.

This article offers only an outline; it is not a definitive guide to all possible consequences and implications of any specific trust option. For this reason, be sure to seek advice from knowledgeable legal, tax, and financial professionals.

¹ Life insurance policies are subject to substantial fees and charges. Death benefit guarantees are subject to the claims-paying ability of the issuing life insurance company. Loans will reduce the policy’s death benefit and cash surrender value, and have tax consequences if the policy lapses.

The opinions expressed above are solely those of Kondo Wealth Advisors, LLC (626-449-7783, [email protected]), a Registered Investment Advisor in the state of California. Neither Kondo Wealth Advisors, LLC nor its representatives provide legal, tax or accounting advice.

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