Popular Again: Using Life Insurance Trusts to Hedge Against Estate Taxes

January 10, 2022 | Patricia C. Marcin | Trusts & Estates

With the prospect of estate tax exemptions going down and estate tax rates going up, it’s a good time to consider using life insurance as a hedge against potential estate taxes. One way to do that is to add an Irrevocable Life Insurance Trust (ILIT) to your estate plan.

Life insurance proceeds are included in a decedent’s estate for estate tax purposes (assuming the decedent owned the policy). If the proceeds are payable to a spouse or a charity, a deduction equal to the proceeds is permitted, so no estate tax will be due on the proceeds. If the proceeds, however, are payable to anyone else, they will be subject to estate tax if the estate assets, including the proceeds, exceed the estate tax exemption amounts. While the estate tax exemption amounts are currently high – the federal exemption for 2022 is $12.06 million and the New York state exemption is $6.02 million, one must consider the strong possibility that exemption amounts will be reduced and tax rates increased.

One easy way to keep life insurance proceeds out of your estate is to have an ILIT own the policy. You create the ILIT; the beneficiaries and terms of the ILIT, generally, can be whomever and whatever you would like. The trust is irrevocable. If the funding of the ILIT is done properly and certain administrative provisions are followed, the life insurance proceeds will not be taxable upon your death.

Life insurance is purchased for many reasons, including to protect loved ones, to pay for estate taxes and to equalize bequests to children (ex., one child gets the $5 million business and the other gets $5 million in life insurance proceeds). If you are single, have a $5 million business and $5 million of life insurance that you individually own, your estate tax bill is computed on $10 million, thereby subjecting your estate to New York estate tax in 2021 on $4.07 million (resulting in over $1 million in NY estate taxes). If the life insurance had been held in an ILIT, your New York tax bill would have been computed on $5 million, resulting in $0 New York estate tax in 2021, saving your heirs over $1 million. If the estate tax exemptions go down, the use of an ILIT is even more compelling.

ILITs have some technical rules that your estate planning lawyer can explain to you. Using an ILIT is a simple way to protect your family and lower your estate tax burden during this period of uncertainty.

This article first appeared in the January 2022 issue of Lloyd Harbor Life.


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