Affluent families with considerable wealth often face significant estate tax liabilities upon the death of a family member. To mitigate this risk, many wealthy families turn to permanent life insurance policies that are owned by an irrevocable life insurance trust (ILIT). Specifically, joint life insurance policies can be an effective tool for managing estate tax liabilities.
What is Joint Life Insurance?
Joint life insurance is a type of insurance policy that covers two individuals under one policy. Unlike a traditional term life insurance policy, which expires after a set period, joint life insurance policies are permanent life insurance policies, which remain in effect for your entire life as long as premiums are paid.
There are two types of joint life insurance: first-to-die life insurance and second-to-die life insurance (also called a survivorship life insurance policy).
In first-to-die life insurance, the policy provides financial support to the surviving spouse after the first of the two insured individuals passes away.
In second-to-die life insurance, the policy pays out the death benefit when both policyholders die.
How Joint Life Insurance Can Help Pay Estate Taxes
For affluent families with significant wealth, estate taxes can be a significant burden. The estate tax is levied on the transfer of assets from one generation to the next and can be as high as 40% for estates that exceed the exemption limit. For 2023, the federal estate tax exemption is $12.92 million per individual, but anything above that amount is subject to estate taxes.
Even if a wealthy family’s estate Is below the federal threshold, it is still possible to owe state estate taxes. Twelve states and the District of Columbia have estate taxes. Oregon and Massachusetts have the lowest estate tax exemption levels at $1 million; anything above that amount is subject to state estate taxes.
For wealthy families, joint life insurance can be an effective tool for mitigating this tax liability, particularly if the insurance policy is owned by an irrevocable life insurance trust.
Efficient Transfer of Wealth
When a second-to-die joint life insurance policy is owned by an ILIT, the policy’s death benefit is paid directly to the trust upon the death of the insured individuals. The ILIT then distributes the death benefit to the beneficiaries according to the terms of the trust.
Since an ILIT owns the insurance policy, the death benefit is removed from the estate of the insured individuals, and the life insurance payout is not subject to estate taxes. This makes it an efficient way to transfer wealth to the next generation.
Favorable Tax Treatment
The beneficiary payout is generally received income tax-free by the beneficiaries, making it a tax-efficient way to transfer wealth, too.
If the deceased’s estate is large enough, it will still be subject to estate taxes.
Joint life insurance policies owned by an ILIT provide liquidity to the beneficiary, allowing them to pay estate taxes or other estate settlement costs without having to liquidate valuable assets or real estate holdings. The liquidity provided by the joint life insurance benefit allows families to preserve other assets for future generations.
Preserves Family Business
When a wealthy family has a family business, they may be concerned about the potential impact of estate taxes on the business when the owner passes away.
But with a joint life insurance policy owned by an ILIT, the policy benefit will be paid tax-free to the trust, which can then use those liquid assets to pay any estate taxes – allowing the family business to remain intact. Without the life insurance policy, the estate taxes could potentially force the family to sell the business to pay the tax bill.
By using a joint life insurance policy in an ILIT, the family can ensure that the business remains in the family for future generations. The ILIT structure also allows for greater control over the distribution of assets and can provide additional asset protection benefits.
Joint life insurance policies owned in an ILIT can be an effective estate planning tool for wealthy families. By providing liquidity to the beneficiary and offering an efficient way to transfer wealth to the next generation, these policies can help preserve family businesses and other assets like real estate. For families with significant wealth, it is worth considering joint life permanent life insurance policies as part of a comprehensive estate planning strategy.
To determine if this strategy is right for your specific situation, it’s important to consult with an experienced estate planning attorney and CPA or financial advisor.
Our team at Delap Wealth Advisory is ready to support and advise you. Start a conversation with an advisor today.
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