2. Estate taxes
There may be taxes due on an inheritance, depending on the size of the estate. How much and at what rate has been somewhat of a moving target over time.
For instance, in 2021, up to $11.7 million of an inheritance is exempt from federal taxes and amounts over that level get taxed at a rate of 40 percent. But in 2017, the exemption was only about half that, at $5.49 million. Twenty years before that, in 1997, the exemption stood at $600,000 and the inheritance tax rate was 55 percent.
And the threshold could change further. The current exemption, which is indexed for inflation, will expire in 2025 unless renewed by Congress.
The potential for higher federal estate or income taxes adds up to the need for more efficient tax planning when discussing a legacy, life insurance can play a key part in that as death benefits are passed on tax free. In particular, cash value life insurance deserves strong consideration, not only due to the income-tax free death benefit, but also because of the cash value itself, which can serve liquidity purposes while alive and enjoys tax-deferred growth.
Beyond the federal estate tax question, some states impose inheritance taxes as well.
Life insurance proceeds can be used to help offset whatever taxes may be due on an inheritance. This can help beneficiaries avoid instances where estate assets have to be sold to cover tax obligations.
3. Estate equalization
What if there are multiple heirs to an estate, but assets aren’t that easily split up?
For a hypothetical example, what if a mother dies and leaves a beach house worth $600,000 to two sons and a daughter. The sons live far away and want to sell it immediately. The daughter desperately wants to keep it. To compensate the sons — and avoid a family rift — the daughter would have to compensate them $400,000. What if she doesn’t have the money?
In instances like this, life insurance in an estate plan can be used to fill the gap and equalize an estate inheritance among heirs. In this example one heir, the daughter, would get the beach house while the sons would receive death-benefit proceeds.
This tactic is often used when passing on farms, where breaking up the operation would have negative consequences on its revenue generating ability.
In next blogpost, we will discuss the other 3 uses of life insurance in estate planning.