How to Ensure Life Insurance Proceeds Are Not Taxed

7:24 pm California Trusts, Estate Planning, Tax Planning

life insurance How to Ensure Life Insurance Proceeds Are Not TaxedHaving the proceeds of your life insurance policy taxed upon your death is not just bad luck for your family…it’s bad planning!  If you own a life a life insurance policy and don’t have a plan, it will become part of your estate and subject to estate taxes.

If you are married  — and for same-sex couples this means legally married in a state that recognizes same-sex marriage – and you list your spouse as beneficiary, there will be no estate tax since assets can be transferred between married couples tax-free.  However, if the beneficiary is your son or daughter, the policy proceeds become part of your taxable estate and subject to the estate tax.

To avoid having life insurance proceeds taxed upon your death, you can either transfer ownership of the policy to someone else or create a trust and fund that trust with the policy.  However, if you transfer the policy and die within three years of the transfer date, the proceeds will revert to your estate.  Plus, if the value of the policy is more than $14,000 at time of transfer, it will be subject to a gift tax.  And, if you transfer the policy to another person and that person wants to cash it out at any time, you have no control anymore.

A better option is to transfer your policy to a life insurance trust, which becomes the owner of the policy.  Since a trust is not a person, it will not incur an estate tax when the policy pays off.  The proceeds will then go to the person or persons named as beneficiary of the trust.  A caveat here: when you create a life insurance trust, you cannot be the trustee and the trust must be irrevocable (meaning it cannot be changed) or it will not be excluded from your estate upon your death.

For more information on how to save taxes through trusts, contact our Orange County law firm.

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