Q. You did a story about leaving life insurance to an estate. What happens if it’s left to a family trust?
A. Let’s take a look at how life insurance is treated.
Your gross estate includes all property that you own. This would include any policy insuring your life if you’re the owner of the policy.
As long as you have “incidents of ownership,” the policy would be included in your taxable estate, said Betty Thomas, a financial planner with Lassus Wherley in New Providence.
“Incidents of ownership” allows you to borrow against a policy, assign or cancel, revoke an assignment, name or change a beneficiary, Thomas said.
When a person dies and has an ownership interest in the life insurance policy, the value of the policy will be included in the deceased person’s estate, Thomas said.
This may increase the value of the estate to the point where either federal or state estate or inheritance taxes could be owed, she said.
If the ownership of the policy is changed to the trust, then all “incidents of ownership” have been forfeited, Thomas said.
The distinction here is the ownership of the life insurance policy, she said.
“By changing ownership to an irrevocable trust, you have essentially made a gift to the trust and the gift cannot be revoked,” she said. “The policy is then removed from your taxable estate.”
If the beneficiary designation of the policy explicitly states that the estate gets the proceeds, then the proceeds will be included in the estate, Thomas said.
If this was to happen, not only would the proceeds be included in the estate, potentially increasing the estate value, but they could also be subjected to the claims of creditors, she said.
“If no beneficiary is named, the proceeds will go into the trust and the trust’s beneficiaries will rule, or if the policy beneficiaries are outside of the trust, there is no impact on the estate,” she said. “Keep in mind if existing policies are transferred to an irrevocable trust and you die within three years of the transfer, the policies are pulled back into the estate.”
If the taxable estate is exempt from the federal estate taxes, it’s still important to know your state’s estate tax law.
For New Jersey, the estate tax increased from $675,000 to $2 million for 2017 and it will be eliminated in 2018, Thomas said.
And remember New Jersey also has an inheritance tax. An heir in New Jersey could pay as much as 16 percent inheritance tax depending on their classification, but life insurance that goes to a named beneficiary would not be subject to the tax.
The bottom line is you should make sure you consult with an estate attorney to be sure the trust document is written so that it will do what you want. Also make sure the beneficiary designations are reviewed.
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