How to Use Life Insurance to Fund Estate Tax Liability

Throughout our lifetimes, we are taxed on many things. When income is earned, it is taxed. When items are purchased, they are taxed. When investments are sold at a profit, the gains are taxed. And unfortunately, when many people die, their heirs are levied with what is known as the estate tax.

Estate taxes are defined as being the tax that is imposed on one’s heir’s inherited portion of an estate – provided that the value of the estate exceeds a certain amount. There are certain exceptions to this, however. For example, if an individual leaves everything to his or her spouse, then all assets will transfer to the spouse estate tax free.

Unfortunately, when the second spouse dies, the beneficiaries who inherit his or her assets will then likely be hit with a substantial amount of estate taxes if the amount of assets exceeds the exclusion limit. In this case, it is a good idea to have at least some amount of estate planning in place.

How Life Insurance Can Help to Reduce Estate Taxes

Although people can never completely eliminate estate taxes, these taxes can at least be reduced by the proper structuring of life insurance through estate planning. Without such a plan, you could be at risk of paying unnecessary taxes to Uncle Sam – money that could instead be going to loved ones.

Life insurance can be an important part of setting up a solid estate plan. This financial tool can provide a number of benefits to your estate, including estate liquidity for the payment of tax, wealth accumulation, income replacement for your survivors, and debt repayment options for any obligations that have been left unpaid.

How to Set Up the Plan

When using life insurance to reduce estate taxes, it is essential that the plan be properly set up and implemented. Otherwise, you could actually end up with an even larger tax liability than you started out with. This is because if you retain ownership of the life insurance policy, the policy’s death benefit proceeds will actually be counted as assets in your estate, and will therefore be included in the taxable amount.

With this in mind, you will need to remove the life insurance policy from your ownership. One way to do so is to set up an irrevocable life insurance trust, or ILIT. By making the trust the owner of the life insurance policy, the trust will actually own the policy. Therefore, the policy proceeds will not be counted as a part of your estate’s taxable assets.

When the ILIT is set up, you will begin to gift funds into the trust for the purpose of paying the life insurance policy’s premium. One thing that you will need to do when creating an ILIT is choose a trustee. This is because you are not allowed to serve as the trustee of your own ILIT. Therefore, it will be necessary to choose either another individual, or a corporate trustee.

At death, the life insurance death benefit proceeds will be paid to the trust, where the trust document will provide instructions on the use of those funds. This could include the ability to loan money to your estate, or even to pay an amount to your beneficiaries.

Because the death benefit of the life insurance policy will pass directly to your beneficiaries outside of your taxable estate, the money will essentially replace the wealth that will be lost to estate taxes. If you are needing final expense insurance rates, we can point you in the right direction.

Other Possible Uses for Irrevocable Life Insurance Trusts

ILITs can be used in situations other than estate planning. For example, young parents may create a life insurance trust for the purpose of enhancing the value of their estate if they happen to pass away prematurely.

Because many younger parents have not accumulated a sizeable estate, the death benefit of the life insurance policy can be used for care of their family members if the primary wage earner is no longer alive.

Still others may set up an ILIT to offset assets that are given to a charity. A typical situation may involve someone who makes either a direct gift to a charity or creates a charitable remainder trust. Because the charity receives the assets rather than family members at the time of the donor’s death, the ILIT is set up to benefit the family and to replace the assets.

Taking the Next Step

The setting up of an irrevocable life insurance trust can be somewhat complex. Therefore, it is important to work with a professional who is well versed in estate planning in order to ensure that your trust is set up correctly. Although this process does take some time, it is well worth the effort for the amount of money that it can potentially save you and your loved ones in unnecessary estate taxation.


Susan Wright holds a BA from Michigan State University and an MBA from St. Louis University. Having over 20 years of working experience in the insurance and financial services industry, she has trained more than 10,000 financial services representatives. Susan has had licenses in real estate, insurance, and NASD Securities, and she has earned nine industry professional designations, including CLU, ChFC, RHU, REBC, CSA, CLTC, CCFC, CSS, and ADPA. Read more about her on Google+

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