Secure Your Future: How to Make Life Insurance Tax-Free

Welcome back to another episode of We're Talking Money. I'm Dustin Hocken. Most people think that life insurance death benefit is tax-free. Well, that's only partly true. Life insurance death benefit is income tax-free, but it's not always estate tax-free, and that can be extremely costly, as estate taxes can be up to 40. Today we're going to be talking about a strategy that helps make sure that your life insurance isn't taxed.

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Today we're going to be talking about a strategy that involves two of the 10 wealth management elements: risk management and estate planning. These elements are focused on two things. First, making sure all the what-ifs in your plan are covered. Second, making sure all of your assets pass as efficiently as possible. This is why comprehensive planning is so important. Most of these strategies involve more than one element, and you want to be sure they're all coordinated, because actions in one element generally affect another.

Life insurance can be an incredible financial planning tool, but if you've built up enough wealth, your life insurance death benefit might only be worth about half to your beneficiaries. Estate taxes are something that a lot of our clients need to plan for, and you might need to as well. Estate taxes kick in when there's an estate 8 over 12.92 million dollars for an individual and 25.84 million dollars for a married couple in the year 2023. Any dollar amount above these limits is subject to an additional transfer tax called the estate tax. The estate tax rate is anywhere from 18 to 40 percent, with any dollars above one million dollars being taxed the highest 40 rate.

When estate taxes are due, beneficiaries have nine months to pay the estate tax. This can be a big ask if you have millions of dollars of estate tax. What can you even do in this situation? Well, let me introduce you to an irrevocable life insurance trust.

Picture this: you have an estate tax due of about two million dollars, and your parents, who just passed away, owned a very successful business or a lot of property that you don't want to sell. Well, how are you going to pay the estate tax? Well, what if two million dollars of tax-free cash was just deposited into your account? This is exactly what can happen if you plan properly.

Let's talk about how to set this up. Your goal is to pay estate taxes. You'll want to get a permanent life insurance policy, one that won't expire before you or your spouse do. Most types of permanent policies will work, but the most inexpensive option is what's called the second-to-die policy. This is the type that we normally recommend. After all, if we need to buy insurance, we might as well pay as little as possible, right? Be careful here. Some advisors will sell you a different type of product that costs more, therefore pays a higher commission.

A second-to-die life insurance policy is normally the way to go because it's insuring the lives of two people, therefore cutting down the cost. The insurance company doesn't have to pay a death benefit on the death of the first spouse. They pay the death of the second spouse, therefore they can price the plan accordingly. This is also the go-to strategy if one of the spouses have any health issues, as second-to-die coverage is generally easier to get through underwriting.

Once you're approved for the insurance, the next step is creating the irrevocable life insurance trust, or ILIT. The ILIT is the tool that gets the insurance out of your estate. You'll want to work with an attorney to be sure all the language is crafted properly. If you need an estate planning attorney, please reach out to us here at OmniStar. We have plenty of Alliance Partners who've done this exact strategy for many of our clients. Once we have the ILIT set up properly, the trust will be named the owner and the beneficiary of the second-to-die insurance policy.

Now we need to pay for the policy, so how are we going to do this? Well, because this is an estate planning technique, we're going to be gifting the premiums to the trust. Based on the current rules for grantors, or the insureds in this case, you can give up to seventeen thousand dollars per spouse per beneficiary per year. So what that means is if you have two beneficiaries, or two children, you can actually give up to sixty eight thousand dollars of premium to the ILIT without having to use any of your gift tax exemption.

The last step that we don't want to miss is completing a Crummey letter to each beneficiary of the trust. The Crummey letter lets the beneficiary know that a gift has been made to the trust, and they usually have a certain amount of time where they can actually withdraw the money, usually 30 days. After the 30 days, the gift is used to pay the life and insurance premium. This may seem strange, but we need to do this to change the premiums from our future gifts to a present gift. By giving them access to the premiums, this allows us to use that 17 000 per spouse per beneficiary per year gift tax exemption.

Having a family meeting to discuss the strategy is extremely important, so your beneficiaries know not to withdraw any of the cash. If they withdraw the cash, there won't be any money there to pay the premium and life insurance policy elapsed, and therefore there won't be any of that tax-free money to pay the estate taxes in the future. Having family meetings are important because you want to make sure everyone's on the same page and everyone knows the strategy. The more educated and in tune the family can be, the more likely it is that the strategy will be successful long term.

I know there's a lot of steps and this can be confusing, so if you think that you might need to implement a strategy like this, please don't hesitate to reach out to us at OmniStar and we can help guide you in the right direction and put together the correct team. It's also important to note that wealth doubles every seven to ten years on average, so if you're 60 years old today and you're worth five million dollars, it's likely you might have some estate taxes due in the future, and if you don't plan properly, most likely your beneficiaries are gonna get hit with a lot of tax.

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