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Phone: 201-345-3018

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How does life insurance factor into estate tax planning?

When a New Jersey resident dies, his or her estate is subject to taxation. Effectively reducing these taxes is an integral part of estate planning. There are a number of ways to limit the taxes that will come with the transfer of assets following a death. Life insurance is one estate tax planning tool that can be used to ensure that loved ones have the means to pay any remaining taxes.

The proceeds from a life insurance policy can be excluded from one’s estate if the following conditions are met. The deceased must not have been the owner of the policy, and he or she must not have had control over the policy for a period of three years preceding death. The best way to fulfill these requirements is to establish an Irrevocable Life Insurance Trust, or ILIT.

With this form of trust, the ILIT itself acts as owner and beneficiary of a given life insurance policy. In this way, the individual who obtains the policy is removed from those roles. This allows the proceeds of the life insurance to be exempt from one’s estate, and therefore not subject to estate tax. Individuals can name one or more trustees, who will be able to access the funds once their loved one has passed away. The trustees can then use the proceeds to cover costs associated with the estate, such as estate taxes, and any remaining funds can be distributed among the trustees.

When considering life insurance options, it is important to understand how these policies can factor into one’s overall estate tax planning strategy. By creating an Irrevocable Life Insurance Trust, individuals can pass wealth on to heirs free of estate taxes. Even more important for some, the proceeds of such a policy can provide the funds that heirs in New Jersey will need to cover the estate taxes on other assets, as well as pay for additional costs related to settling the estate.

Source: rafu.com, "RETIREMENT TIPS: Life Insurance and Your Estate Plan", Alan Kondo, July 21, 2014

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