In previous posts we have discussed in some detail how a properly structured life insurance policy will provide tax benefits during your lifetime. But have you considered what happens (from a tax standpoint) at your death? As a general rule, the death benefit proceeds from a life insurance policy are not taxed as income to your beneficiaries. This means, when a beneficiary receives the death benefit, it is not considered a taxable event; they will only pay their regular taxes. It will be as if they have not received the death benefit
Although the death benefit generally transfers to your beneficiary tax free, the IRS and your state’s taxing authority may still find an opportunity to get their hands on some of that money. If you own the policy at the time of your death, the death benefit will be included as part of your estate, and could trigger estate taxes. The current estate tax exemption is $5.34 million, so as long as your estate value remains below that number, there should be no estate taxes. However, in a properly structured life insurance policy, the death benefit will continue to increase, and could push the total value of your estate over that limit, causing a taxable event. Transferring ownership of the policy—at least three years prior to your death—will prevent your death benefit from being counted as part of your estate.
With the obvious goal of trying to avoid paying taxes—whenever legally possible, of course—what can you do to avoid triggering estate taxes, or simply adding to the estate taxes already being paid? Regardless of who you are and what your estate currently looks like, you should have an effectively designed estate plan in place. An estate plan will help your beneficiaries avoid confusion, and, if well executed, can prevent some, or all estate taxes. There are a number of estate-planning tools to assist in this scenario: trusts, business entities, etc. An estate-planning attorney can structure your estate plan using these tools to avoid taxes both during your life, and when your estate is in the hands of your beneficiaries.