Life Insurance In Your Estate       

If you're like most people, the proceeds collected from your life insurance will make up a large portion of your estate and, if you're not careful, the proceeds can end up being taxed twice when your spouse passes on. Typically, when life insurance is acquired by a couple, one member is listed as the owner of the policy and the other as the beneficiary. 


Under these circumstances, the life insurance proceeds will be included in the purchaser’s gross estate and taxed accordingly. If not consumed, those same proceeds will be subject to estate tax again in the survivor’s (beneficiary’s) estate.


Of course, the best way to avoid estate taxes is to keep valuable property out of the estate. 

Of course, the best way to avoid estate taxes is to keep valuable property out of the estate. The introduction of the unlimited marital deduction has eliminated the tax savings available under prior law for gifts of life insurance to one’s spouse. This is true because simply naming one’s spouse as beneficiary results in 100 percent of the proceeds qualifying for the marital deduction.

Thus, it would seem that current planning techniques suggest the use of an irrevocable life insurance trust (discussed below) for the married couple. If the insured is single, an outright gift of the life insurance policy to the beneficiary continues to be an attractive estate planning tool.

An existing life insurance policy may be transferred to a beneficiary and therefore not be includable in your estate if (1) no incidents of ownership in the policy are retained, (2) the beneficiary of the policy is not your estate, and (3) the transfer of the policy is not within three years of your death.

The gift tax on the lifetime transfer will be less significant than the cost of retaining the policy in your estate. The annual gift tax exclusion (discussed later) may be used to reduce the value of the gift. Your life insurance consultant will be able to advise you of the value of your policy for gift tax purposes.

Irrevocable Life Insurance Trust

For a married couple, significant savings may be obtained by assigning the life insurance on either spouse’s life or on the death of the survivor of both spouses (as in a second-to-die life insurance policy) to an irrevocable life insurance trust for the benefit of the surviving spouse and the insured’s other heirs. Typically, the terms of such a trust are

  1. The surviving spouse receives income for life. Upon his or her death, the trust terminates and distributes its assets to the surviving heirs.
  2. The trustee has the power to invade principal for the benefit of the surviving spouse.

These savings can be accomplished without any real economic detriment to the surviving spouse, since he or she not only has the right to receive income from the trust for life, but also has, at the trustee’s discretion, the ability to invade principal if necessary.

This kind of transfer in trust raises problems with respect to the payment of future premiums. These problems require careful analysis and planning to avoid related income and gift tax implications.

Normally, the transfer of ownership of a group term life insurance policy will not produce a significant gift tax liability, but any policy having a cash surrender value may create gift tax problems. One may borrow the cash surrender value before the transfer or simply pay the gift tax, if any.