You’ve worked hard to purchase your own home and the possessions that fill it. You’re confident that your estate will help provide for your children and partner once you’re gone. But what will be left once the taxman comes knocking? Read on to discover how to avoid losing your estate to hefty taxes.
One of the big questions that a lot of people have about life insurance is why they should get a policy if they have other savings, or if they already have net worth that will outlive them.
Note that your estate is only subject to Federal Estate Taxes if the total value exceeds $5.34 Million (for 2014). Your individual State may have estate taxes as well, and amounts vary by state.
Never Make Contracts Payable to Your Estate
Many Americans write “payable to my estate” when signing agreements like IRA accounts, annuities, or life insurance policies. They don’t see any further than the opportunity to increase their estate’s value. However, this isn’t always a good thing.
If you name a real person as your beneficiary instead, your estate won’t enter probate. Instead of the courts settling your affairs in a lengthy process, someone you trust will do it for you. This is generally much less stressful, more affordable, and faster for the loved ones you’re leaving behind.
Leaving these policies to your estate will also increase its value, which can make it subject to much higher estate taxes.
Get a Current Valuation of Your Assets
We know that it’s a relatively small percentage of Americans who have significant net worth. The majority of households are cash-strapped, and live paycheck to paycheck. But there are still a lot of people out there who, for one reason or another, have been blessed with a lot of ‘extra’ lying around in the form of assets.
These may have been inherited, or a business took off, or someone became famous in a particular industry. Whether it’s real estate, boats, or other expensive toys, or money in the form of elaborate trusts or funds, people with net worth often measure this capital fairly often, and work it into their financial planning for the long-term.
So what’s the deal with having a life insurance policy if you already have assets? Isn’t that redundant?
Before you die, it’s important to make sure you have your assets appraised to establish a fair market value. This is especially important if your estate contains hard-to-value assets, such as a closely-held business or a rare antiques collection. A recent appraisal will ensure the IRS is unlikely to dispute the figure you’ve arrived at.
If such a dispute occurs, the IRS could potentially value your assets at a greater amount than you expect, which would increase your estate’s total value. In turn, this shift could leave your state liable for higher taxes than you’d expected.
Transfer Assets or Your Estate to Your Spouse
If you pass away in 2014 with a taxable estate that’s worth more than $5.34 million, the IRS will tax 40 percent of the surplus. You can avoid this tax by reducing the value of your estate until it’s worth $5.34 million or less. If you’re married to a United States citizen, bequeathing assets, or even your entire estate, to your surviving spouse is one of the simplest ways to do this.
You can bequeath an unlimited amount to your spouse without any tax penalty, so long as they’re an American citizen. Alternatively, you can transfer an unlimited amount of assets, tax-free, to an American spouse before you die. You can also make as many transfers as you like under a privilege known as unlimited marital deduction.
If you’re married to a non-citizen, unlimited marital deduction won’t apply to you but there are ways to get around this. One of the most obvious is for your spouse to become a citizen of the United States. This can even occur after you’ve died, so long as they receive citizenship before the due date for filing the estate’s federal tax return. This deadline is usually nine months after your passing.
To become a U.S. citizen, someone generally has to renounce the citizenship of their home country, so this isn’t the best option for some people, particularly if they intend to return to their homeland or buy property there. If your non-citizen spouse is unwilling to become a U.S citizen, you could reduce your taxable estate by making large gifts to them before your death.
Typically people can make tax-free annual gifts of $14,000, but this limit is increased to $145,000 for spouses. Making a lump sum gift of this amount to your spouse every year before your death is a great way to reduce the value of your estate and eliminate taxes after your death.
Transfer Your Life Insurance Policy to Another Person or Entity
Your life insurance policy will be subject to federal estate taxation if it’s in your name. You can avoid this by transferring it to another trusted adult or entity. A good candidate might be your policy beneficiary, such as your spouse. New owners must pay the premiums on the policy, but there’s nothing stopping you giving up to $14,000 tax-free (or more if you’re married) to the new policy owner to cover these costs. You’ll also give up your right to make changes to the policy, but the new policy owner can make any desired changes on your behalf.
The decision to make someone else your life insurance policy owner isn’t one to take lightly though, because it’s irreversible. Ensure divorce or family fallouts aren’t on your horizon before committing to this tax dodge.
Also note that if you die within three years of gifting your life insurance policy to someone else, it will still be subject to federal tax, so this isn’t action to take on your deathbed.
Establish an Irrevocable Life Insurance Trust
Another way to remove life insurance proceeds from your taxable estate is to establish an irrevocable life insurance trust, sometimes known as an ILIT. This type of trust can’t be altered or terminated without the beneficiary’s permission. Essentially the grantor removes all of his or her rights to the trust and its assets. These assets might include investments, life insurance policies, a business, or cash. In giving up ownership, the grantor is not liable for any taxes on the income generated by these assets.
You might choose to establish an ILIT, rather than transfer ownership of your life insurance policy, if you wish to keep some legal control over the policy. When you give your life insurance policy to your beneficiaries, they can do whatever they like with it. In contrast, when you create an ILIT, your named trustee must follow any instructions you put into the document. These instructions can protect your policy’s cash value and dictate how the trust’s funds are managed and distributed once you’re gone.
As ILIT’s are managed by a trustee, they are also ideal if your beneficiaries are minor children. This trusted person will handle the trust’s proceeds until your beneficiaries are old enough to do so responsibly.
Just like transferring ownership of a life insurance policy, an ILIT is subject to the IRS’s three-year rule. If you die within three years of establishing an ILIT, it will still be subject to federal tax.
By putting these strategies in place you can now make sure you don’t lose your estate to taxes when you’re gone.
The Role of Assets
One way to look at an asset is that it’s just a symbol for a pile of money. But that’s not always the real role that assets play in our lives.
If you have a big house, you live in it. You don’t want your family to have to move out of the house if someone dies. The same goes for a boat, a business, or a college savings account. The bottom line is that you don’t want family members to have to sell assets based on what happens to you down the road.
There are also tax implications to consider. If you are already paying capital gains tax or other taxes on accrued assets and capital, you don’t want to have to bleed that money out in ways that won’t get you tax savings or write-offs. This is part of that whole delicate dance that people play with the Internal Revenue Service, and it’s a major part of financial planning. Having a life insurance policy means that funeral money and other expenses will not have to be taken out of assets as the proverbial ‘pound of flesh.’
A Big Funeral
Another argument for having sufficient life insurance is that, for people with net worth, a funeral is often a big event, in the same way that a wedding or graduation party is. People end up spending a lot of money, money that shouldn’t have to come out of household finances, even if there is enough money in the budget to go around.
Another corollary argument here is that people with net worth are much more easily able to buy high-dollar life insurance policies. $25 or $50 a month might seem like a lot for somebody living paycheck to paycheck, but for somebody with $100,000 and up in the bank, it’s very affordable. But, at the same time, getting a policy isn’t any more expensive for a high net worth individual than it is for somebody who’s waiting for payday — and you can’t say the same about other long-range financial plans like Medicare, which actually charge wealthier people more for services. By contrast, a millionaire can still get a $500,000 policy for just a couple of hundred dollars a year – (assuming they’re in good health, etc.)
People with high net worth can also strategize better to pay less for life insurance. They can take out policies at younger ages, to lock in low premium rates.
All of this makes the excellent case that life insurance isn’t just for people who couldn’t otherwise cover their funeral expenses. It’s really for everybody, and it’s a common-sense way to handle finances just like paying attention to your annual federal tax return, or putting money into an individual retirement account or 401(k). To take a look at what’s out there and see how you can benefit from an affordable life insurance policy that will help your family prepare for the unexpected.
Call us today for a quote at 1-888-552-6159.