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Avoiding estate taxes after a life insurance payout

Many in Miami may be counseled on the wisdom of taking out a life insurance policy to help ease the financial burden their loved ones may feel when they die. One of the more attractive aspects of a life insurance policy are the perceived tax advantages it offers, specifically that beneficiaries do not have pay income tax in its proceeds. Yet while that is true, many do not consider that a life insurance payout may suddenly force their loved ones to become subject to estate taxes.

Section 2042 of the Internal Revenue Code (as shared by the Legal Information Institute of the Cornell University Law School) outlines the scenarios in which a life insurance payout may be counted towards the gross value of one’s estate. These include cases where the proceeds of one’s insurance will be paid to his or her estate, or if one either owns the policy or has retained certain “incidents or ownership” over it. For the purposes of this law, “incidents of ownership” are defined as being the right to:

  •          Cancel the policy
  •          Add or remove beneficiaries
  •          Borrow against the cash value of the policy

When the aforementioned guidelines apply to one’s policy, then his or her beneficiaries may be forced to pay the estate tax if, after adding in the value of the payout, the total value of his or her estate exceeds the tax threshold. According to Forbes Magazine, that value for 2017 is $5.49 million for individuals, and $10.89 million for married couples.

Estate taxes may still be avoided even with the addition of a life insurance payout if one plans accordingly. He or she can create an irrevocable life insurance trust, or can choose to have a beneficiary (other than his or her spouse) own and pay premiums on the policy. 

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