Skip to main content

Passing-On Insurance Policies Tax Free

Article Summary

  • 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.

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, all 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.

 

Mercer Advisors Inc. is the parent company of Mercer Global Advisors Inc. and is not involved with investment services. Mercer Global Advisors Inc. (“Mercer Advisors”) is registered as an investment advisor with the SEC. The firm only transacts business in states where it is properly registered or is excluded or exempted from registration requirements.

All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change. Some of the research and ratings shown in this presentation come from third parties that are not affiliated with Mercer Advisors. The information is believed to be accurate but is not guaranteed or warranted by Mercer Advisors. Content, research, tools and stock or option symbols are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. For financial planning advice specific to your circumstances, talk to a qualified professional at Mercer Advisors.

Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that the future performance of any specific investment, investment strategy or product made reference to directly or indirectly, will be profitable or equal to past performance levels. All investment strategies have the potential for profit or loss. Changes in investment strategies, contributions or withdrawals may materially alter the performance and results of your portfolio. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for a client’s investment portfolio. Historical performance results for investment indexes and/or categories, generally do not reflect the deduction of transaction and/or custodial charges or the deduction of an investment-management fee, the incurrence of which would have the effect of decreasing historical performance results. Economic factors, market conditions, and investment strategies will affect the performance of any portfolio and there are no assurances that it will match or outperform any particular benchmark.

This document may contain forward-looking statements including statements regarding our intent, belief or current expectations with respect to market conditions. Readers are cautioned not to place undue reliance on these forward-looking statements. While due care has been used in the preparation of forecast information, actual results may vary in a materially positive or negative manner. Forecasts and hypothetical examples are subject to uncertainty and contingencies outside Mercer Advisors’ control.

Talk to Us.