When investors were granted extraordinarily high estate tax exemptions in 2017, the law was crafted in a way that allows these exemptions to expire, reverting to pre-2017 levels. High-net-worth individuals and families should consider whether it makes sense to maximize their lifetime gifts before the exemption changes to approximately $7 million in 2026. Any difference between the current $13.61 million exemption and the reduced amounts after 2025 will be lost if not utilized.
This change could potentially subject many more people to estate tax situations, especially those who are relatively young and not likely to pass away soon, providing ample time for their assets to continue growing. When investors review their assets, they typically consider their homes, retirement accounts, investments, businesses, and more. However, personally owned life insurance policies with a cash value should also be regarded as assets.
Though beneficiaries receive tax-free life insurance proceeds upon the policyholder’s death, often, the spouse is named as the beneficiary due to the unlimited marital deduction. However, upon the spouse’s death, any remaining proceeds in their name become part of the spouse’s estate and may be subject to estate tax.
If you’re using a life insurance policy to reduce the value of your estate, having the policy owned by an irrevocable life insurance trust (ILIT), which is a separate entity outside of your estate, is advisable. Given the current generous gifting limits, you can likely transfer ownership of an existing life insurance policy to the trust without facing any adverse tax consequences. You also will need to gift the premium due to the trust annually. Contributions exceeding the annual gift tax exclusion ($18,000 in 2024) will eat into your lifetime gift tax exemption ($13.61 million in 2024). Beneficiaries of the trust have a brief window to make a withdrawal; however, they should avoid exercising this right to allow the gift to remain in the trust, enabling the trustee to pay the insurance policy premium. This approach also provides you with infinite flexibility in how the trust pays out to the designated beneficiaries.
Additionally, an ILIT can provide immediate liquidity for your heirs to cover any outstanding estate fees or necessary expenses. For example, let’s say your heirs inherit your shares of the family business, the home, and your investment accounts. The estate’s value exceeds the estate tax exemption, resulting in a tax liability. Instead of selling off assets—which could have tax implications—the ILIT could engage in an “arms-length transaction” with the estate, transferring an illiquid asset like a home into the trust while providing the estate with the cash needed to pay any estate taxes due.
Using an ILIT can also help preserve government benefits, such as Social Security disability income or Medicaid, for a beneficiary. Assets held within an ILIT are generally protected from the grantor’s and beneficiary’s creditors. Furthermore, an ILIT can facilitate legacy planning, as the death benefit of the policy is excluded from the estate, allowing grandchildren and great-grandchildren to inherit free from estate tax and generation-skipping transfer tax.
If you have questions on how an ILIT may work in your estate plan, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email:experts@henssler.com
- Phone:770-429-9166
Listen to the March 9, 2024 “Henssler Money Talks” episode.
