04 Sep Death taxes and a life insurance policy

Q. My brother, sister and I were sole beneficiaries on a $10,000 life insurance policy on my father, who passed away in late 2016. What taxes need to be paid, if any, on these funds? I know there were new inheritance and estate tax rules for 2017, so I’m left confused.
— Unsure

A. We’re sorry to hear about your father.

Although there were some changes to the New Jersey tax laws effective Jan. 1, 2017, New Jersey currently has both an inheritance and estate tax, said Roy Williams, president and founder of Prestige Wealth Management in Flemington and Millburn.

The inheritance tax is imposed on transfers of assets to certain “classes” of individuals.

In general, Williams said, immediate family members such as a spouse, child, grandchild or parent are considered Class A beneficiaries and transfers to these individuals are not subject to the New Jersey inheritance tax. Other relatives and friends who fall into other classes will face the tax.

But there is an exception for life insurance proceeds.

Life insurance paid to a named beneficiary other than an estate or a trust is not subject to New Jersey inheritance tax even if the beneficiary is someone other than a Class A beneficiary, Williams said.

He said this is an important exception when doing planning.

“For example, if someone wants to leave money to a niece or nephew, a Class D beneficiary, they might want to name them as beneficiary of life insurance,” Williams said. “This would save the 15 percent inheritance tax generally paid on transfers to Class D beneficiaries.”

Williams said life insurance proceeds are not considered income to the beneficiary.

“This means the beneficiary does not have to pay income tax on what they receive, other than accumulated dividends or interest — usually some interest accrues from the date of death until the insurance is paid out and this amount would be taxable,” he said. “If any part of what you receive is taxable income, you should receive a statement from the insurance company to that effect.”

As you said, there was a big change in the New Jersey estate tax law this year. As of Jan. 1, 2017, the exemption amount was increased from $675,000 to $2 million per person. The estate tax is based on the value of a deceased person’s gross estate which includes life insurance.

“Since your father died in 2016, the exemption amount at that time was $675,000,” Williams said. “If the total value of his assets was less than this amount, then there is no estate tax due.”

Also note that as of Jan, 1, 2018, the New Jersey estate tax will be repealed and will no longer be imposed on any estate.

But the inheritance tax was not repealed and transfers to persons other than immediate family will still be subject to inheritance tax, Williams said.

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This post was originally published in September 2017.