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When most people think about the benefits of having a life insurance policy, they are usually thinking about the benefit of financially providing for loved ones in the event of an unanticipated death. What most people do not realize is that a life insurance policy is a tax-efficient way to transfer wealth to your beneficiaries. Before I go into more detail on the tax benefits of life insurance, it is important to understand the estate tax and inheritance tax. The estate tax is based on the assets a person owns when they die. The federal estate tax exclusion is $5.45 million per individual and $10.9 million with portability for a married couple. New Jersey has an estate tax exclusion of $675,000 per individual and Pennsylvania does not have an estate tax. Less than 1% of estates are subject to the federal estate tax so it is really the state estate tax we are concerned with. The inheritance tax is based on the relationship between the decedent and the beneficiary receiving an inheritance. The death benefit of a life insurance policy is included in the gross taxable estate of the policy owner. This means that the death benefit increases the amount of the estate tax owed by the policy owner. One way to avoid this consequence is to plan with an Irrevocable Life Insurance Trust, aka ILIT, which excludes the policy from the decedent’s taxable estate, thereby allowing the beneficiaries to receive the proceeds without owing an estate tax or inheritance tax. You should consult with your attorney and insurance advisor to discuss whether an ILIT makes sense for your planning. Generally, life insurance proceeds are not subject to the inheritance tax, which makes it an extremely useful vehicle to plan in states that have an inheritance tax like New Jersey and Pennsylvania. I’ll provide a New Jersey and Pennsylvania example to illustrate how planning with life insurance can save taxes. In New Jersey, Class A beneficiaries – parents, grandparents, children, grandchildren, etc. – are not subject to the inheritance tax for any inheritance received whether it is life insurance, annuities, bank/brokerage accounts, real estate or any other asset; however, Class C – siblings – and Class D beneficiaries – everyone else – are subject to the inheritance tax if they receive an inheritance other than the proceeds of a life insurance policy. For example, let’s assume a New Jersey man wanted to provide for his longtime girlfriend, a class D beneficiary, after his death. The best way to do so would be through life insurance because she would receive the proceeds inheritance tax free; however, had the man decided to leave his girlfriend real estate or bank/brokerage accounts, the bequest would be subject to the New Jersey inheritance tax. In Pennsylvania, generally only surviving spouses are exempt from the inheritance tax. Everyone else is subject to the inheritance tax in PA, which makes using life insurance as a wealth transfer vehicle even more appealing for all classes of beneficiaries. If you are concerned about your beneficiaries’ inheritance tax implications, an elder law attorney can plan for this situation and refer you to a trusted insurance professional to prepare the most appropriate, tax-efficient estate plan for your family. |
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