31 Jan Using life insurance to save on taxes

Q. For a senior citizen with no spouse or children, and whose only relative is a sibling, how can purchasing life insurance — and using specific provisions of it — benefit a person who wants to minimize the tax burden?
— Senior

A. The decision to purchase life insurance is a very personal one, so it’s hard to give a solid answer without knowing more about you.

Among the issues here are your financial position, your potential tax burden if you were to die without life insurance and who might suffer financially if that happened.

But here’s what you need to know about these issues in general.

Let’s start with term life insurance, which has no value unless the insured dies.

Death benefits are income tax-free in most cases, and premiums on the policy are not tax-deductible, said Ed Gaelick, a Chartered Life Underwriter and Chartered Financial Consultant with PSI Consultants in Glen Rock.

“The death proceeds, however, are included in the deceased’s estate value and that estate may be subject to estate taxes,” Gaelick said. “The death proceeds could provide the liquidity needed to cover some or all of the estate taxes due.”

Then there’s whole life insurance, which builds value while the insured is alive.

Gaelick said premiums are not tax-deductible, but proceeds are income tax-free in most cases.

Like term, the death proceeds are included in the deceased’s estate value and that estate may be subject to estate taxes, he said.

“The death proceeds could provide the liquidity needed to cover some or all of the estate taxes due,” Gaelick said. “The internal growth of the cash value is tax-free unless the policy is surrendered and there is a gain. Then the gains would be subject to income tax at the insured’s ordinary tax bracket.”

If the purpose of the insurance is to minimize the estate tax burden and provide liquidity, Gaelick said, the policy would need to be owned by an irrevocable life insurance trust (ILIT), which would also be the owner and premium payer.

Then death proceeds are paid to the trust — which is not added to the value of the deceased estate — and could provide the liquidity needed to pay any estate tax due, he said.

There’s another possible benefit to consider.

There are long-term care riders that can be included with whole life policies, Gaelick said. These may have some tax benefits for a portion of the premium.

“A policy can be designed to allow additional monies that can be deposited to have some tax benefits, however, many ideas that look to minimize taxes come with scrutiny,” Gaelick said. “Deposit too much money above the normal premium and the policy could have adverse tax consequences.”

Gaelick recommends you speak to an accountant and/or an attorney to discuss the variables, tax implications and to make sure policies are set up properly to accomplish the tax protection you desire.

“This is a perfect example of how a simple answer simply will not suffice,” he said.

Email your questions to .

This post was first published in January 2017.