I’ve blogged in the past about how a Charitable Remainder Trust can help avoid the 3.8% Medicare surcharge and the 20% income tax bracket for capital gain / dividend income. It does so by spreading income out and paying it out when the taxpayer is in a lower income tax bracket.

So, too, life insurance can be used as a way of avoiding these taxes. Life insurance is a tax-free wrapper that can be used to avoid or defer taxes. Only when more than the taxpayer’s basis (i.e., the contributions) is withdrawn from the policy is it subject to taxation. In the interim, the assets are able to grow tax-free.

With a CRT, you get a charitable deduction upon contribution. Of course, with life insurance, there is no charitable deduction upon contribution. However, the earnings inside the policy can be sheltered from income taxes. Thus, like a CRT, life insurance is a way of contributing assets and getting future income sheltered.

Thus, a taxpayer can buy a single premium whole life policy and the income on / growth of the funds can be sheltered. Eventually, when the death benefit is paid out, it goes to beneficiaries free from income taxes. Of course, the death benefit will be included in the taxable estate for estate tax purposes if the insured owns the policy or has any incidents of ownership, like the ability to change the beneficiary. Today’s $5.25 million applicable exclusion means estate taxes are less of an issue for most people. However, if estate taxes are a concern, an irrevocable life insurance trust is still a great way to remove the policy from being subject to estate taxation.

Life insurance is not for everyone. Some people have health issues that make the insurance component too expensive. Depending on the company and policy, there may be other management fees that bring down the overall return. However, it is an option worth considering as a way to lower your clients’ taxes.

Stephen C. Hartnett, J.D., LL.M.
Associate Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (800) 846-1555
www.aaepa.com

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Steve Hartnett

Director of Education, American Academy of Estate Planning Attorneys

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