Triggering Estate Taxability of Life Insurance by Failing to Consider Incidents of Ownership

When are the proceeds of life insurance policies included in a taxpayer’s gross estate?

Fact: the estate tax is set to some fairly generous limits these days, with a married couple able to protect up to $10.5 million together. Consequently, it can be tempting for many taxpayers to simply coast along without concern for exceeding that ceiling. As in past years, however, there is always a danger when it comes to ignoring your life insurance.

Fact: without proper planning and structuring, life insurance will become part of the taxation math for your “gross estate” and you could end up getting hit by a state and/or federal estate tax.

Life insurance has always been an integral part of planning for your estate and for your family on your death. Indeed, life insurance is designed precisely to replace the lost income from the loss of a breadwinner. Of course, those planning with life insurance should be mindful of a potential pitfalls in the legal term “incident of ownership.”

A recent WealthManagement.com article tackles this term head-on with an article aptly titled “Incidents of Ownership.” The IRS employs this term to differentiate those life insurance proceeds that will count a part of the “gross estate” value and those that will go scot-free to the family as intended.

Unfortunately, ensuring there are no incidents of ownership is not just about buying the right policy, but structuring the ownership and beneficiary arrangements accordingly. Oftentimes a very specific form of “irrevocable” trust is required. The time to plan for protection of the tax consequences of your life insurance begins before the application for the insurance is inked.

Reference: WealthManagement.com (July 9, 2013) “Incidents of Ownership”