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Keeping Life Insurance Proceeds Out of Your Estate

11.09.15 | T&E Chat

Owning a life insurance policy is a common part of many individual’s estate plans.

If you own an insurance policy on your life and want to keep the policy’s proceeds out of your taxable estate, one option is selling the policy to an irrevocable grantor trust. It is a complex strategy, so don’t undertake this process without the advice of your trust and estate professional.

Selling the policy to an irrevocable grantor trust is preferable to gifting the policy. Here’s why: if you transfer a policy to a family member or trust and then die within three years of the transfer, the policy’s proceeds will be pulled back into your estate. This three-year rule does not apply if you transfer a policy as part of a “bona fide sale for adequate consideration.”

But here’s the catch: the sale of life insurance may trigger the transfer-for-value rule. A transferee who pays valuable consideration for a life insurance policy is subject to ordinary income taxes on the amount by which the proceeds received exceed the consideration and premiums the transferee paid.

An irrevocable grantor trust solves this problem because it’s structured so that you, the grantor, are the owner for income tax purposes but not for estate tax purposes. So the transfer-for-value rule won’t apply because, for income tax purposes, you’re essentially transferring the policy to yourself.

Complex? Yes. Contact your Berdon advisor for assistance.

Scott T. Ditman, a tax partner and Chair, Personal Wealth Services at Berdon LLP, advises high net worth individuals and family/owner-managed business clients on building, preserving, and transferring wealth, estate and income tax issues, and succession and financial planning.