California Probate - Law Offices of Janet Brewer Blog

Should I Create My Own Estate Plan?

“The ongoing coronavirus pandemic has pushed many people to make long-delayed decisions about estate planning. Many people will try the do-it-yourself route via various websites or books. Internet DIY websites make it easy to download forms, but there are mistakes people make when they try do-it-yourself estate planning.”

US News & World Report’s recent article entitled “Do-It-Yourself Estate Planning Mistakes” provides some issues that do-it-yourself estate planners might encounter and why it is best to consult an experienced estate planning attorney.

What are the Right Questions to Ask? Completing a simple and straightforward form—like a beneficiary designation for your IRA— is one thing, but what about tax consequences, probate law, new legislation and court procedures? Are you ready to take these on? The trick is that you may not know what you don’t know. That’s why it’s money well-spent to employ the services of an experienced estate planning attorney.

Is My Situation Complex? Likewise, you may have property and assets all over the country (or world) that require expert advice. You must be certain that your planning, tax planning and financial planning all work together because they’re all interrelated. If you only work on one of these areas at a time, you may create complications in another area and unintentionally increase your expenses or taxes. It can also create headaches and expense for your heirs. If you have a child with special needs, a blended family, or want to control how and where a beneficiary spends your money, a cookie cutter approach won’t do. Instead, you should see an experienced estate planning attorney.

What are the Probate Laws in My State? Estate planning laws and taxes are different in each state.  Your state will have different rules and legal procedures for creating and administering an estate. There are many different state laws that govern inheritance taxes. There are 17 states plus DC that tax your estate, inheritance or both, and the tax laws can affect your situation when planning. Eleven states plus DC have only an inheritance tax. One state taxes both inheritances and estates.

If you mess up your estate planning documents, if could cause significant problems for your family. You best bet is to work with an experienced estate planning attorney in your state. Contact our office today to schedule your consultation.

Reference: US News & World Report (Dec. 18, 2020) “Do-It-Yourself Estate Planning Mistakes”

Did Robert Redford Have a Business Exit Plan?

“Robert Redford officially bought what was once the Timp Haven Resort (now known as the Sundance Mountain Resort) in 1969. This year, he's stepped away, selling the resort to Broadreach Capital Partners and Cedar Capital Partners. While we don't know how much the resort was sold for, the structure of the sale shows how this iconic real estate investor has built a successful exit strategy.”

Motley Fool’s recent article titled “What Robert Redford's Sale of Sundance Can Teach Investors About Exit Planning” says that, in announcing the sale, Redford told the Salt Lake Tribune that he’s been thinking of selling for several years. However, he wanted to find the right partners. Broadreach and Cedar plan to upgrade the resort, add hotel rooms and build a new inn. The companies have also said that they will keep the resort sustainable and practicing measured growth, as well as also continuing to host the Sundance Film Festival.

The 2,600-acre resort has 1,845 acres of land saved from future development through a conservation easement and protective covenants. The 84-year-old actor has had a lifelong interest in the environment and in land stewardship. Redford and his family have also arranged with Utah Open Lands to create the Redford Family Elk Meadows Preserve at the base of Mt. Timpanogos. The gift will reduce Redford's tax liability on his estate.

Both Broadreach and Cedar have extensive hospitality experience, but neither looks to have much ski resort experience. However, they're working with Bill Jensen, an industry legend, who recently left his role as CEO of Telluride Ski and Golf Resort in Colorado.

Business exit and succession planning can be difficult—in part, because people don't like to address such unwelcome topics. Most investors don't have the luxury of waiting years to find the right buyer, but the Redford deal does show that planning ahead may be critical to creating a mechanism that supports the vision for the property.

When selling a large investment property, you must first understand why you're selling, and your desired end result. Of course, a return on investment is nice, but there may be other considerations, like in Redford's case. Another key is ascertaining the updated worth of what you're selling. Get a valuation, especially with an irreplaceable asset.

The structure of the sale is important. You will likely be liable for tax on your capital gains, so ask an attorney. If you're also structuring your estate plans at the same time, you'll need to know what amount you can give and what your heirs may have to pay. Talk to an experienced estate planning attorney to be certain that you’re covering all the bases.

Reference: Motley Fool (Dec. 12, 2020) “What Robert Redford's Sale of Sundance Can Teach Investors About Exit Planning”

Is a Tax Change a Good Time to Check My Will?

A last will and testament can make certain that your goals for legacy and asset disposition are satisfied and carried out. However, what most people fail to grasp is that a will needs regular review—especially if the document was written or involved the creation of a trust prior to passage of tax reform, the Tax Cuts and Jobs Act (TCJA), in 2017, says Financial Advisor’s recent article entitled “Tax Changes Make This A Good Time To Revise A Will.”

Wills can pass on assets, but taxes have come to greatly impact how much money is passed on. People usually understand the primary components, including the tax implications, of their wills.

These include:

• The unlimited marital deduction
• Applying current rules to make non-taxable gifts of up to $15,000 per person
• The current estate tax exemption of $11.58 million
• Health care directives
• Naming trustees and executors; and
• Creating long-term trusts with non-taxable asset transfers.

Wills and trusts were created prior to the passage of the TCJA may not consider that reform changed the amount which can be exempted from estate taxes.

The law more than doubled the amount that can be exempted from estate taxes. The potential tax changes could cause many more Americans to have a taxable estate, and it’s important to have a full understanding of your assets and carefully decide who you want to receive them. You must also decide if you want them passed outright or through a trust.

Privacy is a good reason why some people often prefer trusts. They also like the quick processing and avoiding probate.

Estate plans should be reviewed every few years, and wills should be reviewed more frequently because life changes are the biggest reason for trouble in revising wills.

Divorce, separation or marriage; the birth or adoption of children, as well as a child reaching adulthood; and changes to finances, location, and health all can play important roles.

Reference: Financial Advisor (Nov. 9, 2020) “Tax Changes Make This A Good Time To Revise A Will”

Should a Donor-Advised Fund Be Part of My Estate Planning?

“With the prospect of a Biden administration potentially raising tax rates and cutting estate tax exclusion amounts in half, some well-off taxpayers may be looking for a way to ease their burden, even while contributing to their favorite charities. A donor-advised fund may well be that opportunity.”

A donor-advised fund is a charitable-giving vehicle that lets a donor make grants to a charity over a period of years. Bizrate’s recent article entitled “Donor-advised funds: A popular tax-advantaged way to give to charity” explains that an individual makes a charitable donation to a fund sponsor, such as a nonprofit foundation or an investment firm, and the donor takes a tax deduction in the year the initial fund was established. The money can be distributed in later years by the fund sponsor under the advisement of the donor.

Once the fund has been created, the money can’t be returned. When the fund is established, the donor establishes the rules for how money is to be gifted. However, the sponsor technically controls the fund. The donor’s advice on what to fund isn’t binding. However, it's uncommon for the sponsoring organization’s board to exercise its variance powers and disregard the advice of the donor. The funds that aren’t granted out each year can be invested. That way, an initial charitable gift can eventually yield far more than that initial gift in total gifts going to end-use charities.

To get a tax advantage out of these funds, you need to itemize your deductions. As a result, you’ll need to have deductions more than $24,800 for a married couple or $12,400 for an individual taxpayer in 2020 (or $25,100 and $12,550, respectively, in 2021). If you don’t hit those thresholds, the donor-advised fund has no net tax benefit.

A donor-advised fund is simpler and less expensive than other similar vehicles, like a private foundation or a charitable trust. It also provides numerous other benefits that can make it a wise choice for donors.

Tax management. The possibility of tax law changes may attract some individuals because the Biden administration has said it’s looking at raising the capital gains tax rates on wealthier taxpayers. The President-Elect has also mentioned decreasing the amount of money that can be excluded from the estate tax and eliminating the step-up in cost basis on inherited assets.

Simplicity. A donor-aided fund may let you create one plan to manage all your charitable giving and allow the fund sponsor to do the administrative work.

Anonymity. If it’s created via a community foundation, a donor-advised fund can be used to make anonymous gifts.

Advice. The fund sponsor can help the donor choose the charities to support or how to manage the giving process, which can help newer or less informed donors.

Flexibility. Some may have liquidity and want to devote cash to charity but are unsure of which charities to support. The donor-advised fund allows the donor to make the initial gift now and make grants in the future. As a result, donors can take the tax break now and decide later where to give the funds.

Teachable giving. Young and adult children can participate in the gift advice process and can be given the opportunity to serve as the fund adviser after the death, incapacity, or resignation of their parents.

The difference from a charitable trust. A donor-advised fund differs from a charitable trust, depending on the specific trust. However, a significant difference is that with a trust, the individual donor can still benefit in some way. In contrast, with a donor-advised fund the money is effectively given away with no ownership.

When using a charitable lead trust, some of the principal will be distributed to beneficiaries, compared to a charitable remainder trust, where you receive annual income, and the charity gets money in the future.

A donor-advised fund is a completed charitable gift. There is no element of continued ownership or control, and no income flow going back to the beneficiaries.

Because of the complexity surrounding these planning issues, it’s wise to speak with an experienced estate planning attorney. You can read more about how our process works, how we can make sure we are a good fit for your needs, and how to get started today right here.

Reference: Bizrate (Nov. 9, 2020) “Donor-advised funds: A popular tax-advantaged way to give to charity”

What are the Biggest Estate Planning Mistakes?

“Taking a few simple steps now can potentially help save your beneficiaries thousands in legal fees and taxes.”

One of the largest wealth transfers our nation has ever seen is about to occur, since in the next 25 years, roughly $68 trillion of wealth will be passed to succeeding generations. This event has unique planning opportunities for those who are prepared, and also big challenges due to the ever-changing legal and tax world of estate planning.

Fox Business’ article “5 estate planning disasters you'll want to avoid,” discusses the biggest estate planning errors to avoid.

Failing to properly name beneficiaries. This common estate planning mistake is easily overlooked, when setting up a retirement plan for the first time or when switching investment companies. A big advantage of adding a beneficiary to your account, is that the account will avoid probate and pass directly to your beneficiaries.

Any account with a properly listed beneficiary designation will override what is written in your will or revocable living trust. Therefore, you should review your investment and bank accounts to make certain that your beneficiaries are accurate and match your intentions.

Naming a minor as a beneficiary. This can be a problem, if they are still minors when you die. A minor won’t have the legal authority to take control of inheritance or investment accounts until they reach the age of 18 or 21 (depending on state law). When a minor receives an asset as a beneficiary, a court-appointed guardianship will be created to supervise and manage the assets on behalf of the minor. To avoid this mistake, you can name a guardian for the minor child in your will.

Forgetting to fund a trust. Creating a trust is the first step, but many people don’t properly fund their trust after it’s established.

Making a tax mess for your heirs. A significant advantages of passing on real estate or other highly appreciated investments or property, is that your beneficiaries receive what is known as a “step-up” in basis, so that they aren’t responsible for any income taxes on the appreciated assets when they are received. The exception is when inheriting retirement accounts, such as 401k’s and traditional IRAs. Except for a surviving spouse, inheriting a traditional IRA or 401k means that you are now responsible for the taxes owed. With the recent passage of the SECURE Act, most non-spouse beneficiaries must totally withdraw a 401k or IRA within 10 years. It is deemed to be ordinary income for beneficiaries, which could result in a huge tax bill for your heirs. To avoid this, you can convert some or all of your retirement account assets to a Roth IRA during your lifetime, which lets you to pay the conversion taxes at your current income tax rate—a rate that may be much lower than your children or grandchildren’s tax rate. When you pass away, any money that is passed inside a Roth IRA goes tax-free to your heirs.

Failing to create a comprehensive estate plan. Properly establishing your estate plan now, will care for your loved ones financially, and can also save them a lot of emotional stress after you’re gone.

Talk to an experienced estate planning attorney about planning now. It can really affect your family for generations. It is one of the best gifts that you can leave your family.

Reference: Fox Business (Nov. 12, 2020) “5 estate planning disasters you'll want to avoid”

Estate Planning: How to Maximize What You Leave Behind

Anticipating and arranging what you leave behind for your heirs is imperative. Knowing how to maximize what you leave behind is the key. 

Many people in the United States feel woefully underprepared for retirement, let alone leaving behind assets for loved ones. However, the estate planning process provides many opportunities to protect your assets and minimize your tax liability, ensuring that they last for your lifetime and that more of your money is passed to loved ones.

A knowledgeable estate planner will be able to give you advice that ensures you are able to transfer the maximum assets possible by employing several strategies, including:

1. Set Up a Trust

Trusts protect the interest of your heirs, and they ensure that asset transfers occur according to your wishes. They also allow your heirs to avoid probate court and protect assets from creditors and divorce proceedings in the family. If your assets are substantial, you may also want to consider setting up a Dynasty Trust (also referred to as a Legacy Trust or Generation-Skipping Trust). 

These trusts can leave some assets for future generations of your beneficiaries, such as grandchildren and great-grandchildren. Depending upon your unique circumstances, you may want to consider several different types of trusts. An experienced estate planner can help you understand all of your options and decide which is the best choice to meet your unique needs.

2. Minimize Your Tax Burden

Depending upon the financial vehicles you use to transfer assets, various tax treatments may apply. For instance, certain inherited assets, such as stocks and mutual funds, receive favorable tax treatment, and leaving these assets to heirs can result in significant tax savings. Gifting assets to beneficiaries while still alive is another common strategy. 

Eligible gifts that are excluded from the gift tax (generally those below $15,000 in value given to an individual or $30,000 for a married couple) are entirely tax-free and do not require a gift tax filing. Similarly, any bequests made to charitable organizations are not subject to taxation, and they are deductible from your ordinary income. If you plan to leave any assets to charity, it’s a good idea to understand how they can benefit you and your estate by reducing your tax liability.

3. Establish Life Insurance or Tax-Deferred Variable Annuities

When life insurance policies are paid out, the beneficiary receives the proceeds without paying taxes on the funds. This leaves a guaranteed benefit to your heirs, unlike other investments that rely on market performance. In addition to these policies, you might want to consider fixed or variable annuities, which allow you to invest in mutual funds or fixed-income investments. 

Another benefit is that annuities held in a 401(k) plan are portable, allowing those who inherit them to transfer the annuity into another plan, rather than forcing them to liquidate it immediately, which can result in charges and fees. Before identifying which plans or annuities might be beneficial for your assets, it’s important to understand that some of these plans come with hidden fees or charges, so you must understand all of the fine print up front. 

This is another area where a skilled estate planner can help you understand your options and their benefits and drawbacks.

4. Creating Timelines & Managing Debt

In many instances, retirement accounts, such as IRAs and 401(k)s allow you to defer paying taxes until the money is withdrawn. Once retired, you can withdraw from these plans and pay taxes on the derived income. When it is beneficial for you to defer withdrawing, an estate planner can help you understand when the best time would be for you or your heirs to start deriving benefits from these types of accounts. 

Knowing when to start can often result in significant savings, allowing more of your assets to be enjoyed by you and your surviving heirs. Properly managing debt is another crucial aspect of maximizing your transferable assets. Your heirs don’t necessarily inherit your debt, but creditors can come after your assets to cover any outstanding debts, which can reduce the value of your estate. While you are alive, it is best to create a plan for settling outstanding debts and ensure that you do not accumulate new ones.

Estate planning can be complicated, and thinking of one’s demise is never a fun activity. But what you leave behind is your legacy. And even those who have many assets might be leaving their beneficiaries a much smaller amount if they haven’t adequately planned and taken advantage of strategies for maximizing the value of the assets that they can transfer upon death. 

For these reasons, you must work with an expert estate planner. The amount of money they can save your estate for your beneficiaries makes this action one of the best financial moves you can make.

What Is a GRIT and Should It Be Used in an Estate Plan?

“Trusts can be useful in estate planning for passing on assets to your heirs. A grantor retained income trust (GRIT) is a specific type of trust that allows you to transfer assets, while still benefiting from the income they generate.”

Creating a GRIT (grantor retained income trust) could have some benefits, particularly if you’re seeking for ways to minimize taxes in your estate plan. A GRIT is a type of irrevocable trust. This means that the transfer of assets is permanent and can’t be reversed.

Yahoo Finance’s recent article entitled “What Is a Grantor Retained Income Trust (GRIT)?” explains that a grantor retained income trust lets the person who creates the trust transfer assets to it, while still being able to receive net income from trust assets. The grantor keeps this right for a set number of years.

With a GRIT, the grantor (or creator of the trust) has the right to receive net income from the assets held in the trust. The trustee distributes income to the grantor, according to the trust terms. After the initial term during which the grantor is eligible to receive income from the trust expires, one of two things can happen. The remaining assets in the trust can be distributed to its beneficiaries. If you don’t want the assets to pass on to beneficiaries immediately, you can set it up so the assets continue to be held in trust.

However, unlike other types of trusts, there are rules on who can get a transfer of GRIT assets. Specifically, there are certain people who can’t be named as a beneficiary to a GRIT, including your spouse, your parents or spouse’s parents, your children or spouse’s children, or your siblings or spouse’s siblings (or their spouses).

However, you can designate the children of your siblings or other distant relatives as the beneficiary to a GRIT.

A GRIT is typically used for one specific purpose, which is to minimize taxes in estate planning. Keeping estate taxes as low as possible results in additional assets to pass on to your beneficiaries when you pass away.

When assets are transferred to a GRIT, they’re valued at a discount. This is based upon on the number of years for which you plan to draw income from the trust as the grantor, and the principal value of assets included in the trust are excluded from your estate for estate and gift tax purposes. However, you’ll be taxed on the income you receive from a GRIT during the initial term. It’s taxed at your ordinary income tax rate. It’s important to know about creating a GRIT for the purpose of minimizing estate taxes, that you must outlive the initial term. If you die during the period when you’re still receiving income from the trust assets, no estate or gift tax benefit would pass on to your beneficiaries.

A grantor retained income trusts can serve a specialized objective as part of your estate plan. However, whether you need one can depend on a variety of factors, so speak with an experienced estate planning attorney about the specifics of a GRIT. Contact our office today to schedule your consultation.

Reference: Yahoo Finance (Oct. 23, 2020) “What Is a Grantor Retained Income Trust (GRIT)?”

Incorporating Gifting with an Estate Plan

“Gifting sounds pretty simple, but there are many ways to do it. There are also several tax ramifications to be aware of.”

Kiplinger’s recent article entitled “Gifting sounds pretty simple, but there are many ways to do it, and several tax ramifications to be aware of as well” explains that no matter if a gift is made this year or in future years, there are some important questions to consider.

Increased exemption. The Tax Cuts and Jobs Act significantly upped the lifetime gift, estate and generation-skipping tax exemption to $11.58 million per individual ($23.16 million per couple). It’s set to expire at the end of 2025. Thus, there’s the prospect of possibly losing an opportunity to transfer wealth out of your estate and save on future estate taxes earlier than anticipated.

When to Give. A big question is whether a person should give away assets during their lifetime or at their death. Those who opt to gift while they’re alive often do so to reduce their estate and to share in the joy of seeing the effect it makes in the lives of the recipients. Others decide to gift after death for the security of having the assets on hand, if they’re needed. Gifting after death also gives recipients time to prepare for the responsibility that comes along with inheriting wealth.

Unified Federal Estate & Gift Tax Exemption. There are many ways to distribute assets. What works for one family isn’t necessarily the wisest strategy for another. Note that any transfer is gift tax-free up to the annual exclusion amount ($15,000 per person per donor in 2020). Any gift over this amount will count against the donor’s lifetime exemption amount. After that lifetime exemption is used, the gift will be subject to gift tax.

Outright cash gifts. This appears to be the most uncomplicated way of gifting. However, for those with significant wealth, this approach could have some drawbacks. These concern the ability and experience gift recipients have to manage money, outside risks, such as a spouse or high-risk professions, and demotivating recipients to live off their inheritance, instead of becoming productive on their own. Therefore, distributing large amounts of money—particularly at a young age—is generally discouraged.

Trusts. These are used frequently for larger gifts to provide for beneficiaries, while using controls by the grantor. These parameters can include things like distributing trust assets in stages (when the beneficiary reaches a certain age or achieves a specific goal). You can also leave assets in a discretionary lifetime trust, which would maintain the assets in a trust for the beneficiary’s entire lifetime. When set up by an experienced estate planning attorney, this offers a high level of protection from divorcing spouses, lawsuits, poor financial decisions and outside influences. It can also let the grantor create a lasting family legacy for many generations.

Gifts for education or medical expenses. Direct payments for college tuition or for medical expenses have no gift tax consequences. Educational gifts can also be made by funding a 529 educational savings plan. While there are no contribution limits for a 529 plan, gifts over the annual exclusion amount can have gift tax consequences or count against the lifetime exemption. You can also pre-fund an account up to $75,000 and it will receive the same tax treatment, as if it were gifted in $15,000 increments over five years.

Uniform Trust to Minors Act (UTMA) and Uniform Gifts to Minors Act (UGMA). These custodial accounts are generally less restrictive than trusts and let minor beneficiaries access funds at age a specific age depending on state of residence.

You can read more about how our process works, how we can make sure we are a good fit for your needs, and how to get started today right here.

Reference: Kiplinger (Oct. 30, 2020) “Gifting sounds pretty simple, but there are many ways to do it, and several tax ramifications to be aware of as well.”

What Do I Do If Property I Just Inherited Has a Mortgage?

“What happens if you inherit your loved one’s home? What if they still have payments to make on their mortgage? We’ll explore these and other questions you may have below.”

Bankrate’s recent article entitled “Does the home you inherited include a mortgage?’ explains that when a family member dies, there can be questions about wills, inheritances, and how best to settle financial affairs. It can be a stressful time, and complicated, especially when real estate is a part of the equation. Let’s look at some specific situations and how to address them.

Inheriting a mortgage. In many instances, a person will inherit both a home and the mortgage that goes with it. If that’s the case, ask for help from an attorney who specializes in elder law or estate planning. Even though the borrower died, the mortgage still must be repaid. Therefore, if you’ve inherited it, you’ll have to decide how the loan and property will be handled. If you move into the home, you may be able to assume the mortgage and continue paying it. You might also think about a cash-out refinance and pay that way. You can also sell the home. Heirs have a good deal of leverage dealing with a mortgage in an estate situation thanks to federal law, which can help them assume an existing loan. You should ask your attorney about estate taxes and capital gains taxes from a sale.

Assuming a mortgage. Typically, if you’re assuming the loan, the lender will be willing to work with you. Mortgages frequently have a “due-on-sale” or “due-on-transfer” clause that requires full repayment of the loan, in the event of a change in ownership. In certain estate situations, federal law prevents the lender from calling the loan, even if it has such a clause. Surviving spouses also have special protections to ensure that they can keep an inherited home.

Inheriting a reverse mortgage. If the home involves a reverse mortgage or a Home Equity Conversion Mortgage (HECM), your options vary according to the circumstances of the borrower who died. If you inherited a reverse mortgage from a parent, your options include the following:

• Paying off or refinancing the balance and keeping the home
• Selling the home for at least 95% of the appraised value; or
• Agreeing to a deed in lieu of foreclosure.

There is a six-month window for the balance to be repaid. This can be extended, if the heir is actively trying to pay off the debt. If the reverse mortgage isn’t paid off after a year, the lender is required by HUD to begin the foreclosure process. This has negative connotations. However, it is a normal part of settling a reverse mortgage, once the last borrower or non-borrowing spouse passes away. If you’re a surviving spouse, and you’re on the reverse mortgage, nothing will change.

If the mortgage is underwater. If the value of the inherited home is less than the outstanding mortgage debt, the home has negative equity or is “underwater.” If the mortgage is a non-recourse loan (the borrower doesn’t have to pay more than the value of the home), the lender may have few options outside of foreclosure. The same usually applies for a reverse mortgage: the most that will ever have to be repaid, is the value of the home. The heirs are fully protected if the home isn’t worth enough to pay off the entire HECM balance.

When there’s no will. If a borrower dies without a will, there will be more complications and expenses when handling a home with a mortgage (or any other assets). Talk to an experienced estate planning attorney regarding your specific situation. 

Contact our office today to schedule your consultation.

Reference: Bankrate (Oct. 22, 2020) “Does the home you inherited include a mortgage?’

Will I Owe Taxes on My Life Insurance Benefit?

“Life insurance is an essential part of estate planning. When you buy life insurance, it's important to make sure the policy payout will be enough to take care of your loved ones.”

MoneyWise’s recent article entitled “Are Life Insurance Benefits Taxable?” explains that, although the proceeds from a life insurance policy are usually tax-free, there are some exceptions. Life insurance payouts may be subject to taxes in the following situations:

A high-value estate. The federal estate tax exemption is $11.58 million this year, so if you leave an estate worth more than that, the IRS will charge a tax of 18% to 40% on the excess amount. It’s possible that life insurance proceeds could get taxed, if they're part of a high-dollar estate. To avoid this, you could create an irrevocable living trust to shield your assets from taxation. Ask an experienced estate planning attorney for help.

State inheritance or estate tax. Estate and inheritance tax laws are different in every state, so your estate or heirs may have to pay taxes on the death benefit, depending on where you reside. There are six states that have inheritance taxes (IA, KY, MD, NE, NJ, and PA). There are also a dozen states and the District of Columbia that have their own estate taxes (CT, HI, IL, ME, MD, MA, MN, NY, OR, RI, VT and WA).

Gifts. You can also avoid estate or inheritance taxes by transferring your life insurance policy to a beneficiary, while you're still around. You may have to pay a federal gift tax on the value of the policy when you do it, but the policy will be worth far less than the eventual death benefit. You can gift up to $15,000 a year to an individual without any tax. Remember that the policy's new owner will still have to make the payments.

The death benefit skips a generation. If you decide to skip your child and give the death benefit to your grandchild, the money would be considered taxable income by the IRS. That’s due to the "generation skipping transfer tax," which applies if you give any gift or inheritance to a family member who's more than one generation younger than you — or to a nonrelative who's more than 37½ years younger.

Life insurance installment pay-out. While life insurance benefits are typically paid out in a lump sum, some people opt to have their benefits paid out over time. I you do this, tell your heirs that they’ll have taxes on any interest that's added to the benefits, while they're being kept by the insurance company.

Withdrawal from your cash value of life insurance. With permanent life insurance policies that cover you for life (as opposed to time term life), there’s a savings component called “cash value.” During the life of the policy, some of your paid premiums funds the cash value account. You can make a withdrawal from this amount, provided you make a withdrawal that’s less than the amount you've paid into the policy. Otherwise, it’s taxed.

Group life insurance policies. Many companies offer life insurance as a benefit to their employees. If you have a policy at your job, the premiums won’t be taxable income unless the promised life insurance payout is more than $50,000.

Selling your life insurance policy. If you sell your life insurance policy for cash to a buyer or investor who will continue to make the payments and will receive the death benefit when you die, you'll have taxes on any income from the sale.

If you still have questions about how insurance contracts work, speak to an experienced estate planning attorney.

Reference: MoneyWise (Oct. 12, 2020) “Are Life Insurance Benefits Taxable?”