Estate Taxes: How to Prepare Your Client’s Heirs for Taxes on Their Estate

The Estate Tax, on its face, seems unfair to most people. Essentially the federal government (and several state governments) levy a second tax on money that a person has accumulated over their lifetime after that person passes away. While people under the current threshold of $12.97 million dollars will not have to pay the Estate Tax, those families with assets and wealth beyond that will pay close to 40% in some cases on any value above the threshold. Let that sink in for a minute.

If a family’s total assets are $15 million dollars, the heirs will have to come up with $800,000 dollars cash to pay Uncle Sam. The problem is that while their family is wealthy, that wealth might be in the form of a business, a family farm, homes, and other real assets. This forces families to sell precious assets to pay the Estate Tax. Let’s learn about the ways your client can leverage life insurance to alleviate this incredible tax burden.

Life insurance for the win: Hedging against the Estate Tax with sound policies

Life insurance can be a valuable tool for hedging against estate taxes, as it can provide a significant death benefit that can be used to pay off any taxes owed. Here are some of the best ways to leverage life insurance in order to hedge against estate taxes:

1. Use life insurance to pay off estate taxes: One of the most straightforward ways to use life insurance to hedge against estate taxes is to purchase a policy that will pay out a death benefit large enough to cover any taxes owed. This can be especially useful for individuals with a high net worth, as estate taxes can be quite substantial.
2. Create an irrevocable life insurance trust (ILIT): An ILIT is a trust that is created to hold a life insurance policy, and it can be used to provide a source of funds to pay estate taxes. The trust can be set up so that the death benefit is paid out to the beneficiaries tax-free, which can greatly reduce the overall tax burden.
3. Make use of the annual gift tax exclusion: Another way to use life insurance to hedge against estate taxes is to make use of the annual gift tax exclusion. This allows an individual to gift up to a certain amount each year to an individual without incurring any gift taxes. This can be used to purchase a life insurance policy and transfer it to an ILIT or to another individual.
4. Use life insurance to fund a buy-sell agreement: Many business owners use life insurance to fund a buy-sell agreement, which provides a way for the business to continue in the event of the death of one of the owners. This can also be used to provide a source of funds to pay estate taxes in the event of the death of a business owner.
5. Use permanent life insurance: Life insurance policies that accumulate cash value, such as whole life or universal life, can be used to hedge against estate taxes as the cash value in the policy can be used to pay off taxes or to provide a source of funds for the beneficiaries. This allows the policyholder to accumulate cash value over time, which can be used to pay estate taxes or for other purposes.

The irresistible benefits of an Irrevocable Trust and Life Insurance for wealthy families

A life insurance policy placed inside an Irrevocable Trust is one of the most effective tools for avoiding Estate Taxes. This tool is beneficial because it allows individuals to provide for their heirs without having to pay a high rate of taxes on their estate. When set up properly, the proceeds from the life insurance policy are paid directly to the trust upon death, thus bypassing any probate or estate taxes. By paying out before taxes are due, this helps reduce the overall tax burden of the estate.

One major benefit of an Irrevocable Trust is that it eliminates any potential creditor claims against the trust beneficiary. Since a trust can be used as an asset protection tool, this means that creditors cannot access funds that are within the trust after death. The assets remain protected and secure against potential claims or actions taken by creditors and other parties who may have an interest in the estate itself.

In addition to providing protection against creditor claims, these trusts offer several other tax advantages such as “stepped-up” basis and income tax savings on gains from investments within it. When a trust is established lifetime gifting can also occur which will reduce future estate taxes and possibly eliminate them depending on how much money was gifted away during life. 

With proper planning, expensive Federal Estate Tax can be completely avoided if there are enough assets in the trust upon death because all assets passed to beneficiaries are excluded from taxation under federal law.

By using an Irrevocable Trust along with a life insurance policy, individuals can ensure their families or heirs receive financial security without being burdened by large amounts of taxes when they die. With appropriate planning and execution, it’s possible to minimize or even avoid costly Estate Taxes while still providing valuable benefits for loved ones at the same time.

Tying it all together

Now you understand how life insurance can be a valuable tool for hedging against estate taxes. By purchasing a policy that will pay out a death benefit large enough to cover any taxes owed, creating an irrevocable life insurance trust, making use of the annual gift tax exclusion, using life insurance to fund a buy-sell agreement, and using permanent life insurance, it can help reduce the overall tax burden and provide a source of funds for the beneficiaries.

Your clients depend on you to understand these nuances so that you can help them achieve and maintain their financial and life insurance needs.  CORE is here to help you navigate these rules and taxes on behalf of your client.  Let us know how we can help you get the most value for your client’s hard-earned money.