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How to Protect Life Insurance Benefits from the Estate Tax


The estate tax is a tax that is applied to people’s estates after death. In some cases, this burden could wind up compromising over 50 percent of the value of the estate. While common taxable assets that people think of include houses, cars, and investment portfolios, many people don’t realize that life insurance proceeds could also be taxed even though these are awarded only when a person dies. Without careful planning, a significant amount of life insurance benefits could wind up in the hands of the government instead of the hands of loved ones.


Life Insurance Benefits are Taxable under Certain Circumstances

Most people take out life insurance policies because they generate a large amount of money that can help out a spouse of children in the event of someone’s death. When people realize that life insurance benefits are subjected to federal income tax, they often breathe a sigh of relief; however, they are subject to the estate tax under as stated in the IRS tax code. If is included in the gross value of an estate if the proceeds are payable to either:

  • The estate itself
  • Named beneficiaries receiving the estate

While this might sound like specific circumstances, they cover almost everyone who possesses a life insurance policy. If only there was a way to circumvent this estate tax on life insurance benefits.

A Transfer of Ownership

Whether or not life insurance proceeds are taxed depends on who owns the policy at the time of the policyholder’s death. In order to avoid the estate tax, the person in question should perform a transfer of ownership. This will transfer ownership of the policy to another person or an entity. The person giving up ownership rights of the policy will lose all power to make changes to the policy in the future. Therefore, the person receiving the ownership rights should be a competent adult who is capable of paying the premiums on the policy. Also, request a written form from the insurance company stating that the ownership has been changed.

Life Insurance Trusts

People can also establish an irrevocable life insurance trust for their life insurance proceeds. For this option to work, the person originally holding the policy cannot be the trustee of the trust and cannot have any right to revoke the trust. In this route, the trust holds the policy and therefore will not be included in the value of the deceased’s estate. The trust will contain detailed instructions on how the benefits of the life insurance policy will be disbursed while also removing a significant asset from the gross value of the estate. For more information on life insurance proceeds and the estate tax, please consider contacting an experienced estate planning attorney for guidance.

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Dunlap & Seeger, P.A.
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Rochester, MN 55904

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