Will beneficiaries face the inheritance tax?

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Q. My spouse and I both have life insurance policies of $500,000 on each other. We have no children. We are each named as the primary beneficiary on each other’s policies, and our contingent beneficiaries are a brother and a niece. Would they be subject to the inheritance tax if they get the proceeds?
— Trying to avoid it

A. While the state’s estate tax is gone, the inheritance tax remains.

The inheritance tax is determined by the relationship between the deceased and the beneficiary, but in this case, you’re in luck.

Life insurance, when paid to a named beneficiary or a trust for the benefit of a named beneficiary — regardless of the relationship of the beneficiary to the decedent — is one of the specific assets that is exempt from the imposition of New Jersey inheritance tax, said Catherine Romania, an estate planning attorney with Witman Stadtmauer in Florham Park.

If the life insurance was left to your estate, and the estate was passed to your brother and niece under your will, it would not be exempt from the inheritance tax, Romania said.

“It does not matter that your brother and niece are named as contingent beneficiaries on the life insurance policies, provided they are in fact named as beneficiaries on the policy and will not be taking the proceeds as beneficiaries under the will,” she said.

The New Jersey inheritance tax is levied against certain bequests, and transfers within three years of death, based on the relationship between the deceased and the beneficiary and the value and nature of the asset transferred, Romania said.

There is no inheritance tax imposed if the beneficiary is a spouse, domestic partner, civil union partner, grandparent, parent, descendant or stepchild of the decedent, or a charity, she said. If the beneficiary falls into one of these categories, the value or nature of the bequest is irrelevant.

“If the beneficiary does not fall within one of these categories, then the relationship to the beneficiary and the value or nature of the bequest must be considered to determine if there is an inheritance tax,” she said.

Transfers to a sibling, son-in-law or daughter-in-law, referred to as Class C beneficiaries, are not taxable up to the first $25,000. Transfers in excess of $25,000 up to $1.1 million are taxable at the rate of 11 percent. Transfers in excess of $1.1 million and up to $1.4 million are taxed at 13 percent, and transfers in excess of $1.4 million up to $1.7 million are taxed at 14 percent. Any larger transfers are taxed at 16 percent, Romania said.

All other beneficiaries — including nieces, nephews and step-grandchildren — are referred to as Class D beneficiaries. Transfers to these beneficiaries are taxed at 15 percent if the value is greater than $500 up to $700,000, and at 16 percent for anything valued higher, Romania said.

In addition to life insurance paid directly to a named beneficiary, certain other assets, including public employee benefits such as a teacher, firefighter or police retirement fund, are exempt from the tax, she said.

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