Your life insurance not only acts as a will, but also an important part of your estate planning. The payout to the beneficiaries after your death helps them meet the hefty tax on the estate (which in some cases could be over 46%), in addition to protecting them financially.
However, estate tax becomes a matter of concern when the estate is over $2 million. It will be a prudent step on your part to purchase a life insurance policy as part of your estate planning to pay all the related taxes. It must be remembered that for full realization of the payout from a life insurance policy, the owner of the policy should be the executor of your estate or the beneficiary.
A tax repeal schedule has been developed by the Economic Growth and Tax Relief Reconciliation Act of 2001 that ensures the reduction of estate tax over a number of years and by 2010, it would be completely repealed.
If it is anticipated that the total worth of your assets is over $2 million, it would do well to include a life insurance policy as part of your estate planning. Or else, your beneficiaries would have to pay a hefty estate tax. To provide your beneficiaries with tax-free proceeds after your death, you either have to transfer ownership of your life insurance policy, or put the life insurance policy into an irrevocable trust.
- Transferring ownership - if the ownership of policy is transferred, it does not belong to you, and hence it will not be included in your estate.
- Creation of an irrevocable life insurance trust - as the ownership of the policy is with a trustee, it does not belong to you and hence will not be included in the estate.
In both the above cases, you lose your legal rights of ownership to make any changes to your beneficiaries, or rights to cancel the policy, pay premiums, or borrow against the cash value.