How can I help mitigate inheritance tax for my heirs?

By Brianne King, CFP? manager of financial planning and Brandon Schwan, CFP?, CPWA? senior financial advisor

Over the next few decades, we are poised to see the largest generational wealth transfer in history. Proper planning for this transfer can help save your heirs thousands of dollars in taxes. As a reminder, assets transferred between spouses are inherited free from any estate tax.

An estate is subject to the federal estate tax once all the assets in the estate exceed a certain threshold, which is the federal estate tax exclusion. The federal estate tax exclusion amount, which is the dollar amount of the assets you can transfer free from federal estate tax to your heirs over your lifetime or at death, is the highest it has ever been in history. Estates over the federal estate tax exclusion are subject to federal estate tax up to a 40% rate.

The high federal estate tax exclusion amount is set to sunset on January 1, 2026, which would reduce the federal estate exclusion down to a projected $7,000,000 per person. Even with the sunset, the amount that can pass tax free is still considerable. However, when reviewed in context of the history of the exclusion amount, there was a time not that long ago, that exemption ranged from $675,000 to $2,000,000. We do not have a crystal ball to predict future tax law legislation; however, we can take advantage of the high exemption available now and look at the risk your estate has in paying federal estate tax.

Utilizing a life insurance policy can be an easy and efficient solution to reimburse your heirs from any federal estate taxed owed. In this strategy, a person or couple would purchase a permanent life insurance policy owned by a trust called an Irrevocable Life Insurance Trust, or ILIT.

Having the trust be the owner and beneficiary of the life insurance policy is a crucial component of this estate planning tool. The purchase of the policy inside the trust keeps the life insurance proceeds outside of your estate at the death of the insured(s). You will need to work with your estate attorney to draft the trust on your behalf.

By owning the life insurance outside of your estate, it will not be included in your total estate and will not be subject to the federal estate tax. In this example, heirs of the estate received an additional $1,000,000 of assets.

Now that we understand how life insurance can be a useful tool to transfer wealth, let’s review specific to the type of policy you would want to purchase.

• Policy Type: Permanent – Married couples who are insurable should purchase a second to die life insurance policy. This policy will only pay proceeds once the second spouse has passed away. Spreading the insurability risk over two lives can help to reduce the premium cost of the policy.
• Premiums: Because the insurance is owned by a trust, the money used by the clients to pay the premium is considered a gift to the beneficiaries of the trust. You will want to make sure the premium amount is below the annual gifting limit per beneficiary (currently $18,000 per person or $36,000 for a married couple can be gifted per year for 2024).
• Insurability: From an insurability standpoint, this policy functions the same way as a traditional policy. The policy will have one or two insured (the clients who hold the large estate), and they will have to go through an underwriting process to determine if they are insurable and how much premiums will be based on their health rating.
• Alternatives to a New Policy: If you currently have a permanent life insurance policy owned by you, you may be able to gift the policy to trust to remove it from your estate. The value of the gift at the time of the transfer to the trust will be the cash value of the life insurance policy, not the death benefit.

Estate planning is a very valuable tool for clients of all asset levels. It ensures your money is transferred to your heirs as intended. If you are interested in learning more about how Irrevocable Life Insurance Trusts or other estate planning strategies may benefit you and your loved ones, your wealth advisor at Fragasso, along with your estate attorney, is here to review your projected estate values and discuss all options that align with your family’s goals.

Chart Sources: 1. https://www.irs.gov/businesses/small-businesses-self-employed/estate-tax 2. https://www.thebalancemoney.com/exemption-from-federal-estate-taxes-3505630

Fragasso Financial Advisors and Private Client Services are not tax or legal service entities. Readers of this blog should always consult a tax or legal professional regarding his/her individual situation.