Personally owning life insurance or naming you or your estate as beneficiary could cause the inclusion of the life insurance in your estate assets for federal and/or state estate tax calculation purposes. If your taxable estate value (including the life insurance) exceeds the estate tax exemption amount1
, federal and/or state estate taxes may be imposed on the property that you own at your death. This tax is due in cash and must be paid by your estate within nine months of your death.
On the other hand, if your estate's taxable value (including the life insurance) is under the estate tax exemption amount1
, the ownership or beneficiary designation may have no tax impact on your estate. Our Estate Tax Calculator
can help you estimate if your estate might be subject to estate taxes.
When estate taxes are a primary concern, many individuals relegate ownership and beneficiary designation for their life insurance to a third party, such as an irrevocable life insurance trust (ILIT) or adult children. Either may avoid inclusion of policy proceeds in your estate. Meanwhile, third-party owners may be able to lend these proceeds to, or purchase assets from, your estate to provide cash to satisfy your estate tax liability. (If you make your spouse the owner of a policy on your life, you should ensure that, if your spouse dies before you, you will not end up owning the policy either through a provision in your spouse's will or a living trust.)
Even where the owner is a third party, if the beneficiary dies before you (the insured), the proceeds may be paid to your estate. Naming a contingent beneficiary to the policy will ensure that the proceeds will go directly to that person, thus avoiding probate and estate taxes. The "Rule of Two" holds that a policy should always have at least two contingent beneficiaries in order to avoid such problems.
You should remember that any gift of life insurance to a third party (except to your spouse) may carry with it gift tax consequences2
. Additionally, if you fail to survive your gift by three years, the policy may be brought back into your estate. Because of these potential pitfalls, you should always seek tax and legal advice prior to any transfer.