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Question:


If a policy is for $250,000, does the beneficiary receive $250,000? If this is true, is it safe to say that life insurance should be used for estate planning purposes to avoid sky-high taxes?
-RoryJohns


Answer:


Yes and no. Proceeds of a life insurance policy paid to a beneficiary are not subject to income tax, but they’re considered part of the estate of the person who has died, so the payout could be subject to estate tax. If someone has a $250,000 policy and leaves behind an investment portfolio worth $5 million and nothing else at death, the Internal Revenue Service will value the estate at $5.25 million. But the person’s heirs would have to pay estate tax of precisely nothing.

While estate tax is assessed at 40 percent, which may seem sky high considering that much, if not most, money in a typical estate is what’s left over after some larger amount was taxed at some point in the past, the exemption from taxation is also sky high. There is no liability on the first $5.34 million of an estate. If an estate is likely to be valued higher than that, then the proceeds of an insurance policy could be taxable, but there are steps that the owner of the estate can take to reduce the eventual liability, such as forming a trust or giving money to prospective heirs in certain amounts and at certain intervals. So while life insurance serves useful purposes, estate planning isn’t one of them.

-Conrad de Aenlle



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