By: Sarah Stewart
For 2016, the estate tax exemption is $5.45 million. That means an individual can leave assets valued at about $5.45 million to their heirs without their heirs having to pay an estate tax, which is a rather large amount. In the state of Oklahoma, there is currently not an estate tax amount, so for Oklahoma residents, at least you currently do not have to worry about paying additional estate taxes to the state. In other states, that may not be the case.
Under Federal and some state laws, life insurance proceeds can be taxed to the decedent’s estate when the decedent has an ownership interest in the policy. That means, if the Decedent pays the premiums, changes beneficiaries, or has the ability to withdraw cash from his/her life insurance accounts, the value of the policy may be included for estate tax purposes. So, if we have an individual with an ownership interest in $2 million of life insurance and $3.5 million dollars in other assets, including real estate, business interests, and personal accounts, without proper planning, the estate would be subject to the high federal estate tax, and depending on the state, additional state estate taxes.
If you are in the fortunate situation where that may be a concern for your family, you can avoid having life insurance included in the estate value if you execute an Irrevocable Life Insurance Trust (“ILIT”). Though this type of trust is complex, the general idea is that you are turning over your control and ownership of the policy to a third-party trustee. Because of the complicated issues included in this type of trust, it is best to have a corporate, or extremely tax-savvy, trustee. The insured will make gifts each year to the trustee to pay the life insurance policy premiums.
In order to keep your gift tax exemption (currently $14,000 in 2016) intact, there are certain notices and precautions that must be taken. This includes sending notices to beneficiaries and allowing beneficiaries the, often unexercised, option to withdraw their annual gifts from the trust.
If you do have a large estate that will be subject to estate taxes, the ILIT may also be an option for helping to pay some of those taxes and estate costs. However, if the payment is made outright, there is a chance the payment may be counted as estate income. There are ways to use the trust to make loans and provide liquidity to the estate, such as purchasing estate assets, without having tax ramifications.
If you are in a position to have assets that are over $5.45 million when you die, you may want to consider an ILIT. Also, you may want to keep an eye on the federal and state estate tax laws to make sure this amount does not change with time.
Legislators are continuously updating the tax code. So, though you may feel comfortable where you are now, there may be a change to lower the amount of the estate tax exemption at any given time and you will need to be aware of those changes to protect your estate from high federal, and possibly state, taxes. In those times, remember the ILIT as an estate planning option.