Is life insurance taxable?
This is one of the top 10 questions that clients come to me with.
So I decided to answer that question and provide a guide to life insurance gifting to give you some tools to use in case you step over the state and federal estate tax threshold.
Your taxes absolutely can be affected by receiving a life insurance payout and I’m gonna show you to avoid getting hit too hard by Uncle Sam 😉
Let’s take a look into the tax implications of life insurance policies and how you can use life insurance gifting to lessen the blow.
Is Life Insurance Taxable? Making a Spouse Your Beneficiary is a No Brainer
There appears to be a simple answer to this question. One of the best benefits of having life insurance is that the proceeds aren’t taxable.
Wellllll….that may be true on the face of it, but it’s a little more complicated.
The most common example of a traditional life insurance policy is cut and dried. A husband and wife purchase policies to protect the family if one or the other should die suddenly. Simply put, if your spouse is the beneficiary of the death benefits the money will be passed on tax free!
Whoot! This perk makes the gift of life insurance so much more valuable.
That being said, if you leave the life insurance to anyone else, and this includes you children, the proceeds will be attached to your estate for tax purposes.
….hmmmmm. Makes you think doesn’t it?
One of the benefits of owning life insurance is the ability to generate a large sum of money payable to your heirs in the event of your death. An even greater advantage is the federal income-tax free benefit that life insurance proceeds receive when they are paid to your beneficiary. However, although the proceeds are income-tax free, they may still be included as part of your taxable estate for estate tax purposes. Investopedia, How to Avoid Taxation on Life Insurance Proceeds
You May Have to Consider State and Federal Estate Taxes
The good news is tax issues won’t affect the majority of beneficiaries. Essentially, all life insurance proceeds paid out are non-taxable.
Complications result when you have an estate that transcends state and/or federal thresholds.
For 2017, the estate and gift tax exemption is $5.49 million per individual, up from $5.45 million in 2016. That means an individual can leave $5.49 million to heirs and pay no federal estate or gift tax. Forbes, IRS Announces 2017 Estate and Gift Tax Limits: $11 Million Tax Break
In Some Circumstances Life Insurance is Taxable
If you are wondering “is life insurance taxable?” it’s important for you to note that the Federal exemption creates a pretty high bar that won’t impact the average person. However, I think that a lot of people have no idea just how much their estate is really worth.
If you are estate planning, it’s so important to sit down and really figure out the nitty gritty. Let’s say you own your home and you live in a major city.
Ca-ching! Possibly that asset is worth more than a million dollars!
Do you have investments that have grown over the years or own a business?
How about that collection of art?
A second home?
I am not saying this holds to true for most of us but if you are a business owner or have substantial assets, before you know you may be thrust over the Federal Estate tax threshold.
...And Don't Forget the State Has a Say!
Ok I hear ya! Your estate may not even be close to the Federal threshold of 5.49 million….
Not so quick buster! 15 states still have estate taxes (and some have estate and inheritance taxes but that’s for another day).
Unfortunately, those thresholds are substantially lower and pack a hefty punch. States like DC, Massachusetts & Oregon only exempt $1 million and in today’s worlds that’s not a whole hell of a lot.
So this is an estate planning issue that really should be addressed if you want to avoid your life insurance policy becoming part of your estate for tax purposes.
I Fall Outside the State and Federal Estate Tax Exemptions! Help!
For your circumstances, the answer to the question “is life insurance taxable?” is a resounding yes! Well I certainly have some good news for you!
With a little estate planning you can make sure that your life insurance proceeds don’t get attached to your estate!
If you want to leave the death benefits to your child or someone other than your spouse, you can either set up an irrevocable life insurance trust or gift the policy. Both of these methods transfer the value of the policy outside of your personal estate for tax purposes.
An Irrevocable Life Insurance Trust is a more complicated legal manoeuvre that deserves an article unto itself. Click below for more information.
For now I am going to concentrate on life insurance gifting!
Life Insurance Gifting & How It Can Help Your Beneficiaries Keep Their Money
To recap – if you die and you own a life insurance policy that has not been left to your spouse, the proceeds will be considered part of the estate and may be subject to estate taxes.
So to answer your question “is life insurance taxable?”…
Yep, it very well may be, if you are lucky enough to be in the position of having to consider Federal and State Estate Tax thresholds.
I am going to show you how life insurance gifting can help your beneficiaries keep their money when you die!
The idea is, if you surrender ownership of the life insurance policy to another individual, then the proceeds are no longer considered to be part of the estate and won’t be taxable as such!
In a perfect world, the best type of life insurance to use in this process would be a “single premium” policy. In essence, you pay the entire cost of the premiums up front as a lump sum. It just makes things a bit easier.
If you are paying premiums monthly or annually, the person to whom you gift the life insurance policy must assume the ongoing payments to keep it in force. Quite often the person passing down the life insurance policy will simply give money to his or her beneficiary so that they can continue to pay the premiums to keep the policy from lapsing.
However, please keep in mind that there is a cap on the monetary value of the premiums you can give to the new owner of the policy without incurring taxes. It must be under $14,000 or this sum will be subject to “gift taxes” under IRS regulations.
Life Insurance Gifting! How Do You Do It?
Now that I’ve answered the question “is life insurance taxable” and you now know that gifting life insurance can defray any taxation that may occur you’re ready to find out how to do it!
Luckily life insurance gifting is a super simple process – no lawyers needed my friends!
If you own a permanent life insurance policy such as Whole Life, Universal Life, Indexed Universal Life or some other hybrid variation, the first thing you want to do is ask your insurer what the current cash value is.
You need this information because, as I mentioned above, the IRS imposes a “gift tax” that has a cap of $14,000.00. Anything in excess of this figure is subject to gift taxes.
If you happen to exceed the $14,000 threshold, that’s not a problem. Your life insurer will provide you with the appropriate forms to satisfy IRS requirements.
After this, all you have to do is complete the life insurance company’s “transfer” or “assignment” of ownership in the name of the person to whom you are gifting the policy. You will also be happy to hear that most companies don’t charge you to change ownership of the policy.
Clean and simple!
NOTE: The IRS requires that the new owner of the policy must be in possession for a period of at least 3 years prior to the death of the original policyholder. Otherwise, the death benefits will become part of the estate of the insured and may be subject to estate taxes. It’s a good idea to gift a policy sooner rather than later to make sure this doesn’t happen to you!
A viable solution to this is to maximize your gifting potential and to transfer policy ownership whenever possible at little or no gift-tax cost. As long as you live another three years after the transfer, your estate could save a significant amount of tax – How To Avoid Taxation On Life Insurance Proceeds, Steven Merkel
Life Insurance Gifting How Does it Affect Ownership?
To be in alignment with IRS requirements when you gift a policy, you must essentially surrender complete ownership and the perks that go along with it. This means you must have NO control over the following:
• Changing the names of the beneficiaries: This life insurance policy no longer belongs to you so you have no say in what happens to it once it’s been gifted. Be prepared to relinquish control!
• You cannot borrow against the policy: This is just common sense. The whole purpose of life insurance gifting is to remove the money from your estate…PERMANENTLY 🙂
• You can’t cash in the policy: Times are tough, but you built up some cash value in that policy you gifted. But you can’t cash it in because it’s no longer yours!
• Having a dispute with the beneficiary, you cannot cancel the policy: Any control you had over the life insurance policy is now over. It’s a gift and it’s gone.
• Don’t like the way the proceeds are going to be dispersed? It’s too late: The time to think about this is BEFORE you gift the life insurance policy. Don’t wait until it’s too late.
Points to Keep In Mind When Gifting Life Insurance
Remember gift taxes apply to any amount in excess of $14,000
Gifting Life Insurance to Charity
Gift Your policy to adult children
*Alternatively a named beneficiary or an executor
Children as Beneficiaries
Never gift a policy to your spouse.
If the spouse were to die first, the proceeds would be considered part of their estate.
Why You Need Term Insurance
You don’t need to worry about them in your lifetime. They don’t apply until you die.
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These points may seem very obvious, but you would be surprised by the number of people who don’t realize gifting life insurance means that you will have no future say in what happens to the money.
Some are under the misguided idea that if they need to they will be able to access the cash value or make changes if circumstances change.
This is not a will. You cannot go back and make addendums – a gift is a gift and once you have transferred the policy it’s a done deal. That’s why I advise people to get their ducks in order before they sign it away.
Use an Independent Agent When Life Insurance Gifting!
Is life insurance taxable? No….
Not unless you leave it to someone other than your spouse and it becomes attached to your estate because you fall outside of the Federal & State Estate Tax cap.
For most people this isn’t a concern – but for those of you who have sizeable holdings life insurance gifting may be a way to keep the taxman at bay.
Our independent life insurance agents have a whole host of life insurance solutions for you. Besides saving you a pretty penny on your premiums, we can help you find coverage that fits your particular circumstances.
Call Huntley Wealth today at 877.443.9467, we have access to dozens of life insurance companies and over a decade of experience under our belts. There isn’t a better choice for your life insurance needs.