Transfer Your Life Insurance and Decrease Your Estate Tax
If you don’t own your life insurance policy, it’s not part of your taxable estate.
First things first: You don't have to read this article unless your estate is likely to owe federal estate taxes at your death. Currently, the estate tax affects only people who die leaving a taxable estate of more than two million dollars. (To learn more about estate tax basics, see Nolo's Estate and Gift Tax FAQ.)
For those estates that do owe taxes, whether or not life insurance proceeds are included in the taxable estate depends on who owns the policy when the insured person dies. If the deceased person owned the policy, the full amount of the proceeds are included in the federal taxable estate; if someone else owned the policy, the proceeds are not included.
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Melissa buys an insurance policy covering her life, with a face value of $200,000. Her son Jeff is the beneficiary. Melissa's business partner, Juanita, buys a second policy, also covering Melissa's life, for $400,000, payable to Juanita. (She will use the proceeds to buy Melissa's half of the business after Melissa dies and leaves it to Jeff.)
Melissa dies. All the proceeds of Melissa's policy, $200,000, are included in her federal taxable estate. However, none of the $400,000 from the policy Juanita owns is part of Melissa's federal taxable estate, because Melissa did not own the policy.
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It follows that if you want your life insurance proceeds to avoid federal estate tax, you may wish to transfer ownership of your life insurance policy to another person or entity. There are two ways to do it. You can transfer ownership of your policy to any other adult, including the policy beneficiary. Or, you can create an irrevocable life insurance trust, and transfer ownership to it. (But be aware that some group policies, which many people participate in through work, don't allow you to transfer ownership at all.)
 | Are life insurance benefits subject to the estate tax? |  |
All property that you leave to your spouse, including insurance proceeds, is not subject to estate taxes when you die. Your life insurance proceeds would be taxed as part of your estate only if the beneficiaries of the policy are your children, friends, or relatives other than your spouse.
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