Sep 23, 2014
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April 2014 Archive for Farm Estate and Succession Planning

RSS By: Andrew Zenk

This blog focuses on making complex and difficult topics in estate and business planning understandable and applicable to the reader.

Andy is an Agribusiness Consultant for AgCountry Farm Credit Services, Fargo N.D., a farmer owned cooperative and part of the Farm Credit System serving eastern North Dakota and northwest and west central Minnesota.

Demystifying the Taxability of Life Insurance

Apr 15, 2014

There are a lot of questions and confusion with the taxability of life insurance.  Confusion generally centers on whether it is income taxable, estate taxable, or both?  Your life insurance is not subject to income tax at death, as long as you do not deduct the premium payments from your income taxes.  Although your life insurance policy may pass to your heirs’ income tax-free, it can affect your estate tax. If you are the owner of the insurance policy, it will become a part of your taxable estate when you die. You should make sure your life insurance policy won't have an impact on your estate's tax liability.

Spouses can transfer assets to each other tax-free. But if the beneficiary is anyone else (including your children), the policy will be a part of your estate for tax purposes. For example, suppose you buy a $1 million life insurance policy and name your son as the beneficiary. When you die, the life insurance policy will be included in your taxable estate. If the total amount of your taxable estate exceeds the then-current state or federal estate tax exemption, then your policy will be taxed.

In order to avoid having your life insurance policy taxed, you can either transfer the policy to someone else or put the policy into a trust. Once you transfer a policy to a trust or to someone else, you will no longer own the policy, which means you won't be able to change the beneficiary or exert control over it. In addition, the transfer may be subject to gift tax if the cash value of your policy, which is the amount you would get for your policy if you cashed it in, is more than $14,000 (in 2014, this figure rises every few years with inflation).  If you decide to transfer a life insurance policy, do it right away. If you die within three years of transferring the policy, the policy will still be included in your estate.

If you transfer a life insurance policy to a person, you need to make sure it is someone you trust not to cash in the policy.  For example, if your spouse owns the policy and you get divorced, there will be no way for you to get it back.  A better option may be to transfer the policy to a life insurance trust.  In that case, the trust owns the policy and is the beneficiary. You can then dictate who the beneficiary of the trust will be. For a life insurance trust to exclude your policy from estate taxes, it must be irrevocable and you cannot act as trustee.

If you want to transfer a current life insurance policy to someone else or set up a trust to purchase a policy, consult with your elder law attorney.

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