Life insurance and estate tax go together for the policyholder that has an estate to leave behind to his family and loved ones. While they are together in the sense that they generally go into effect at the same time, there are separate entities that need to be fully understood.
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What is the Estate Tax?
An estate is a property that is left behind by a person who has passed away. The estate can be of any size, but if the value of the estate exceeds a certain level then it is taxed by the government as it is passed from the former owner to another party. It is a one-time tax that is paid when the estate is transferred from one party to another. The estate tax even applies to family members as well even if they live on or use the property that was formally owned by the deceased.
Is Life Insurance Subject to an Estate Tax?
There is no life insurance estate tax per say as the beneficiary of the policy is not considered part of the estate itself. In other words, the beneficiary is the one who has obtained the money through a life insurance policy, not the former owner of the estate. So, life insurance proceeds estate tax in this situation. Click here to learn when you need to pay taxes for life coverage and when not.
How to Use Life Insurance to Pay Estate Taxes?
The estate tax life insurance relationships is present because many policy owners do not want their families stuck with paying the estate tax which can be considerable. So, they structure their life insurance policies to cover paying the estate taxes. While this does leave an increase in the personal income tax of the beneficiary, it is generally considerably smaller than the benefit of having the taxes paid by the policy itself.
In order for the estate tax to be paid by the life insurance, the wishes of the policyholder must be carried out by the beneficiary with the understanding that this is how the money is to be used. Because the payment from the life insurance company will usually proceed when the estate tax is due, this arrangement can be handled by a law firm, accountant, or even by the beneficiary to ensure that the taxes are fully paid.
An important aspect is updating the life insurance policy to ensure that the benefits from it will fully pay the estate taxes. The value of an estate may change considerably from year to year, so it is important to take that into account when planning how to pay the taxes when due.
Planning is essential to the execution of paying the taxes with the money from the life insurance policy. This can also be handled as instructions in the will, but generally speaking there simply needs to be an agreement between all parties involved that the life insurance estate tax is fully paid by the money from the policy.
When handled in this manner, those who stand to inherit can alleviate one of the biggest burdens to receiving estate property by having the taxes paid through the life insurance policy.