Life insurance, a common asset in American households, can pose a significant estate-planning challenge due to potential estate tax implications upon the policyholder’s demise. To address this concern, consider the strategic use of an Irrevocable Life Insurance Trust (ILIT) – a reliable solution to safeguard your assets and maximize wealth transfer.
The Ownership Dilemma
When a policyholder passes away, the life insurance is typically included in the taxable estate, subjecting it to estate tax. While keeping the policy outside your ownership at the time of death can exclude its proceeds from the taxable estate, caution is required. The concept of “incidents of ownership” extends beyond policy possession, encompassing rights like policy amendments or borrowing against its cash value.
In 2024, the top estate tax rate stands at 40%, with a gift and estate tax exemption allowing you to shield up to $13.61 million of proceeds from federal taxation. It’s crucial to note that this exemption will revert to $5 million (adjusted for inflation) after 2025 unless Congress intervenes. State-level estate or inheritance taxes may also be a factor, particularly for wealthier individuals.
Trusted Resolution with ILIT
Enter the ILIT, a common and trusted method for mitigating estate tax challenges associated with life insurance ownership. Setting up the trust as the policy owner or transferring an existing policy to the trust can be instrumental. The key feature of an ILIT is its irrevocable nature, necessitating a complete relinquishment of control. To avoid incidents of ownership, consider appointing a family member or professional advisor as the trustee.
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Designate the ILIT as the primary beneficiary of your life insurance policy. Upon your demise, the proceeds flow into the ILIT, earmarked for distribution to beneficiaries – typically, a spouse, children, or other family members. However, be mindful of potential pitfalls, such as naming a surviving spouse as the sole beneficiary, which could delay estate tax liability until their passing. Consult with your estate planning advisor to navigate these complexities.
Navigating Potential Pitfalls
Transferring an insurance policy to an ILIT requires careful consideration of potential pitfalls. If death occurs within three years of the transfer, the proceeds may be included in the taxable estate. One workaround is having the ILIT purchase the policy and gradually funding it over time. Additionally, the transfer itself is considered a taxable gift, but fortunately, available gift and estate tax exemptions can provide shelter from such taxes.
Conclusion: Tax-Efficient Planning
Whether you hold one or multiple life insurance policies, they can represent a tax liability. However, going without insurance is not a realistic option for those with family members dependent on the financial safety net it provides. To explore tax-efficient planning options, reach out to your estate planner and discuss how an ILIT can play a strategic role in securing your wealth transfer objectives.
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Navigating the intricacies of estate planning, especially in the realm of tax-efficient strategies such as Irrevocable Life Insurance Trusts (ILITs), requires specialized experience and personalized guidance. At Sol Schwartz & Associates, our practice in estate and gift tax planning ensures that you receive tailored solutions to safeguard your wealth and streamline the transfer process. To fortify your financial legacy and address estate tax complexities, contact Sol Schwartz & Associates, where our 43-year track record in tax planning informs our commitment to your financial well-being. Visit our website for more information on how we can assist you in achieving your goals.
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