When it comes to estate planning, every taxpayer has a lifetime gift and estate tax exemption amount. In 2022, the lifetime exemption increased from $11.7 million to $12.06 million. Unless the tax laws change, the lifetime exemption will drop to approximately $6.2 million at the end of 2025. This can pose a tax liability for heirs of estates that exceed the exemption. Therefore, insurance planning in wealth management should be carefully planned and executed.

When it comes to paying the tax, the question is, what is most advantageous way to pay?

Options include:

• Use cash held by the estate.
• Creating cash from the sale of assets.
• Use Life Insurance Proceeds.

The question becomes, which is the least cost?

Many estates do not have the cash reserves needed for the tax payment. In addition, taxes are typically due within 9 months of date of death. In most situations estates are created from the accumulation of assets as opposed to a windfall. Many times those assets include primary residency, real estate portfolio, business value, cash, securities including equities and debt instruments and life insurance (owned by grantors of estate).

Selling of estate assets could raise the funds needed. However, what if the asset values are down forcing a “liquidation” sale? Or the estate has an asset that creates a large percentage of the value? The effect could be as simple as a small reduction in value of the asset to a large discount resulting in the loss of the asset all together.

Life Insurance creates an additional issue. If owned by the grantors, the value of the death benefit is also included in the estate value. For example, a $2 million dollar death benefit gets added to the value of the estate thereby making the (assuming in excess of the total exemption amount) proceeds taxable. If tax rates are 40%, the net effect would be $1.2 million to the heirs ($2M x 40% = $800K. $2M – $800K = $1,2 million) Therefore, life insurance held in an estate subject to taxation only reduces the benefits to heirs.

Use an ILIT

The solve to this dilemma is simple, own the insurance policy OUTSIDE of the estate. How? A simple trust called a Irrevocable Life Insurance Trust (ILIT), can be created by a qualified estate planning attorney. Whereas this type of trust agreement is fairly common, it is important to have the agreement match your overall estate planning needs.

The concept of an ILIT is simple. Once the trust is established, it arranges and purchases a life insurance policy on the life or lives of the grantors. It is important to own the policy FROM THE BEGINNING by the outside entity/trust. Any ownership prior to the trust could result in the IRS “clawing back” the asset into the estate. To help ensure this action does not occur, plan accordingly by using a qualified agent such as one who has a CLU and estate attorney.