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Passing-On Insurance Policies Tax Free


  • The SECURE Act requires many non-spouse beneficiaries to liquidate their retirement account inheritance within 10 years – revisit your trust to make sure it’s set up to minimize tax liability for your beneficiaries.
  • An irrevocable life insurance trust (ILIT) is a special type of trust that governs the management and distribution of a life insurance policy.
  • An ILIT may help offset the significant tax ramifications for your beneficiaries, especially if you have tax-deferred retirement assets.
Passing-On Insurance Policies Tax Free

The SECURE Act has made substantial updates to retirement rules, which means it’s vital that you revisit your 2020 financial plan. One of the biggest changes to the SECURE Act requires that beneficiaries empty out all inherited retirement accounts within 10 years of the account owner’s death. This can result in significant tax liabilities for your beneficiaries. One way to avoid significant tax ramifications is to establish an irrevocable life insurance trust (ILIT). Given the recent changes of the SECURE Act, you may want to revisit your trust to make the appropriate adjustment in order to minimize tax liability for your beneficiaries.


How does an ILIT work?

An irrevocable life insurance trust (ILIT) is a type of trust that governs the management and distribution of a life insurance policy – yes, you can put a life insurance policy in a trust, thereby protecting your proceeds, and your beneficiaries on your death. Since this trust is irrevocable (meaning the grantor no longer has ownership of the assets in the trust), it can only be changed in limited circumstances once the irrevocable trust is set up. The grantor, you in this case, can purchase a life insurance policy and list the ILIT as the owner of the policy or transfer ownership of an existing life insurance policy to the ILIT. In this way, the grantor is essentially gifting the annual life insurance premium amount to the ILIT.

A key benefit of this type of trust is that when the grantor/life insurance policy owner dies, the proceeds from the life insurance policy are paid to the ILIT and those funds are distributed to the beneficiaries according to the terms of the trust. As a reminder, many trusts are created to help minimize taxes for your estate – and this is no different.

A properly administered ILIT removes the value of the life insurance proceeds from the grantor’s estate so that the grantor has reduced estate assets (and therefore pay less taxes on these assets). This exclusion is significant for those who anticipate having estate tax liability, as the ILIT can provide necessary funds to cover estate taxes and final expenses, and the ILIT is excluded from estate taxes. If the requirements of the ILIT have been met, the life insurance policy passes tax free to both the decedent’s (grantor’s) estate and the beneficiaries.


Should I consider setting up an ILIT?

Since an ILIT requires a life insurance policy, you should consider whether you qualify and are eligible, given your age and current medical conditions. If you can purchase a life insurance policy, here are some other considerations:

  • Your net worth exceeds, or will likely exceed, the applicable estate tax exclusion amount at the state or federal level. This is as low as $1 million in some states.
  • You have tax-deferred retirement assets, such as traditional IRAs and 401ks that you hope will benefit your loved ones, especially if Roth conversions or charitable giving would not be appropriate options for you.

If you have further questions or are ready to set up an ILIT as part of your comprehensive estate plan, please contact your Advisor, and our Family Wealth Services group will be happy to facilitate this process for you.

If you want to learn more about the SECURE Act, click here.

Visit our resource center to learn more about the significant retirement changes that may impact you and your financial plan.

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