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Life insurance in your estate

George SaenzDear Tax Talk,
If I specify that my life insurance is payable to my estate (total value of estate $800,000) and specify certain amounts of that insurance money to be paid to various beneficiaries in my will, will those beneficiaries have to pay tax on the insurance money? All amounts would be more than $10,000? -- Carolyn

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Dear Carolyn,
It's usually better to ask these questions before you act. However, in this case you're still within the limits that are tax-exempt.

When you make life insurance payable to your estate, you create an additional estate asset. In 2003 (I'm assuming you'll make it until then), no estate tax is due if the total value of estate assets is less than $1 million. The $1 million is reduced if you previously made taxable lifetime gifts (i.e. gifts in excess of $11,000 to any one person in any year).

Life insurance proceeds are always income-tax free. Although there is an $11,000 cap (up from the historic $10,000) on tax-free gifts, this does not apply to inheritances. Therefore, your beneficiaries will receive their inheritance income and estate tax-free.

Since death proceeds from a life insurance policy can sometimes put an estate over the top for estate taxes, it's usually better to own the policy outside of your estate. This is accomplished through a life insurance trust.

Basically a life insurance trust is an agreement that you make with your beneficiaries to own the life policy and pay its premiums. You usually gift money to the policy owners to pay the premiums. The trust receives the death proceeds and pays it out in accordance with your wishes established in the agreement at the time the trust was formed.

You'll need a good tax attorney to establish the trust as its terms and activities are very technical.

-- Posted: Nov. 13, 2002




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