Find Out How Life Insurance Can Be Your Best Inheritance

Life Insurance and its death benefit can be important components in making plans for your inheritance. If you think there is a possibility that your inheritance could represent a burden for your heirs, you should consider the benefits offered by life insurance. It may help you minimize these problems, including reducing the tax implications of your inheritance.

In this article we will share ways you can use life insurance to help you better plan your inheritance.

Find Out How Life Insurance Can Be Your Best Inheritance

Using Life Insurance to Plan Your Inheritance: Article Contents

Life Insurance and Inheritances: A Mutually Beneficial Relationship

You might have concerns about the inheritance you will leave your loved ones when you pass. If you have a considerable amount of assets and money to pass along to them, you should keep in mind that they are also inheriting taxes. In the United States, large inheritances have significant tax implications, making it necessary to plan them well so that they don’t end up being an overwhelming burden on your loved ones.

As you are likely aware, law states that inheritances are subject to taxes. Beneficiaries of inheritances are required to pay high tax rates. Federal taxes are due on the transfer of assets, and some states also charge a tax on the right to transfer property. In addition, other states also tax the right to receive these assets.

All these taxes mean that your inheritance can become more of a burden than a gift for your heirs. By using one or more life insurance policies, you can help mitigate these issues. When used properly, insurance can help to reduce the tax burden on inheritances for those receiving them.

Of course, the solution is not as easy as just leaving the insurance as part of your inheritance without further instructions and hoping that your heirs divide up the death benefit as they see fit. Failing to name beneficiaries for your death benefit is one of the most common mistakes people make when purchasing life insurance. If you include the life insurance policy as just another part of the inheritance, the beneficiaries will not immediately receive the money. Instead, they will have to wait until the inheritance goes through the legalization process, which can take months, and they won’t be able to access the money until this is resolved.

Rather than making a hasty decision regarding your inheritance, you should lay out a plan, or strategy, for how these resources will be used so that your beneficiaries will know how they will receive the money and what they will be able to use it for.

These plans must be legalized and signed before a notary by the person leaving the inheritance. They stipulate which assets are included in the inheritance (from real estate, such as buildings or land, to cash, all types of assets, stocks, and of course, insurance, as well as any debts of the person leaving the inheritance). Upon the death of the person leaving the inheritance, the plans they laid out must be executed to the letter so that their heirs can receive their funds without delay.

One very important piece of advice: always consult an expert when planning your inheritance. Before you sign an inheritance plan, consult experts on tax, insurance, and other matters who can help ensure that you have the best strategy for your situation.

Taxes and Inheritance: Avoid Paying More Than Necessary

As you most likely already know, life insurance is a product with numerous tax advantages . On one hand you have the cash value that that generates tax deferred income. On the other, loans you can take out against their value also have very low tax rates. And most importantly, the death benefit your beneficiaries will receive from your life insurance are completely tax-free. This favorable tax treatment makes life insurance a useful tool in helping to protect your inheritance from taxes.

This is so important because of the high taxes due on inheritances. Per the Tax Cuts and Jobs Act of 2017, under certain circumstances, an individual who passed away in 2018 can transfer up to $11.18 million dollars (or $22.36 million dollars per couple) without paying federal taxes. Anything above this is subject to a high tax rate of up to 40% on the value of the inheritance. In general, this tax must be paid in a specific time frame and before the heirs can use the assets inherited. This can force many people have to to sell assets, and even businesses, to cover these taxes. Because of this, it is of utmost importance that you take measures so that your heirs don’t pay more than necessary, which is where a life insurance policy can be very helpful.

There are many possible strategies that will allow you to achieve the same goal of reducing the tax burden on inheritances. These plans are beneficial for two important reasons: first, they are based on products with a low tax burden; secondly, the money from the death benefit can be used to pay taxes, leaving the remainder of the assets free to be transferred.

Experts recommend several ways to use life insurance as a way to protect your inheritance. Some of the most frequent are:

  • Using the death benefit to pay taxes. This is very likely the most commonly used strategy. Heirs are designated as beneficiaries of the life insurance policy, allowing them to use the indemnity or death benefit to pay the taxes that will be due on the rest of the inheritance. This ensures that they will receive the wealth inherited without delay. However, there can be problems with this strategy. The most frequent issue arises when the benefits the insured obtains from their policy (the added value) are incorporated into the inheritance, thereby increasing its value, and consequently the taxes due, making it necessary to increase the amount of the death benefit, which is not always possible. Another problem is the fact that the amount of money that can be transferred without being subject to tax changes every year, meaning the calculations are no longer correct and may come up short. These fluctuations can be significant. Over the last ten years there have been times when successions were exempt from federal taxes, and others when the exemption was only one million dollars, and anything above that was taxable. This means that changes in the legal framework can cause your strategy to fail.

  • Set up an irrevocable trust. An irrevocable trust, or irrevocable life insurance trust (ILIT) is an attractive option. This is when you place the life insurance, and all your other assets and property, into the name of a trust that can only be revoked by the beneficiaries if they are all in agreement.
    In the case of marriages, term or permanent life insurance policies are commonly used, but it is almost always last survivor life insurance. This means that the death benefit is transferred to the fund only once both spouses have passed away. From a tax standpoint, these policies offer an important advantage. Since the insurance is in the name of the trust, it ensures that the earnings obtained from the insurance by the first spouse to pass away will be incorporated into their inheritance or that of the surviving spouse.
    The administrator of the trust fund, who can be a professional, acts in accordance with the deceased’s will and decides how the inheritance is managed. The funds from the insurance are also managed from within the trust. The administrator can collect the death benefit or make an agreement with the insurance company on the format that is in its best interest. This frees up the liquidity in the trust for paying taxes. Furthermore, in general, the tax treatment for trusts is very beneficial, meaning that they effectively protect the inherited assets, even against creditors, and reduce the overall taxes that must be paid on the inheritance. On the other hand, it’s important to establish a trust far in advance (at last three years prior to the grantor’s death). Otherwise, it could be considered as illegal and tax evasion.

  • Revocable trust fund. Revocable Life Insurance Trust or RLIT. In this case, the trust works in the same way, but it can be revoked. The grantor retains the right to modify or cancel the trust. This type of trust is generally chosen by young families that have relatively few assets, but significant insurance policies.

Life Insurance as Charitable Donation: Another Way to Avoid Taxes

In addition to the “defense mechanisms” we mentioned above, there is another option to ensure that your life insurance policy provides tax benefits. This is by using the death benefit from the insurance to make a charitable donation.

In this case, the simplest strategy is to leave the insurance as a donation to a non-profit organization. If you leave your policy to this type of entity, you must name it as both owner and beneficiary. This way, your annual charitable donations pay the policy premiums and you can deduct the added value generated by the insurance policy and the money paid for premiums on your annual return.

Beyond this, there are more sophisticated ways to save on taxes through charity. In this case, the strategy consists of establishing what are known as charitable trusts. These types of entities, though not tax exempt, do provide significant tax benefits. The trust is designed so that the interest generated from the funds managed by the trust is used for charitable works in exchange for tax advantages. Some of the available options include what is known as a charitable remainder trust, which is the most recommended because it allows for more tax deductions. A charitable remainder trust is an irrevocable trust where the income is distributed to the beneficiaries, and when the grantor passes away, the money remaining in the fund is donated to charity.

Charitable trust funds also allow you to make more complicated transactions that include life insurance. For example, a person can place their company in the name of a trust, and can later sell it without having to pay taxes on the profit from this. Then, using the distributions from the capital fund, they can buy a life insurance policy, the death benefit of which will replace the value of the company transferred to charity. This is one way to use insurance to avoid paying excess taxes on the transfer of assets, and also make charitable donations.

As you can see, proper planning of your inheritance using life insurance is a smart way to avoid paying the taxes that can turn your inheritance into a nightmare for your beneficiaries. However, not all of these options are simple, and it’s a good idea to always speak with tax experts and insurance agents who can give you sound advice.

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