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AAOS Now

Published 7/1/2014
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Erika Wieland

Using Life Insurance for Estate Planning

Wanting the people we love to be taken care of—even if we aren’t physically there to do so—is a natural emotion. But achieving that goal requires planning ahead and evaluating all aspects of the situation.

Life insurance may be one way to provide the necessary funds. But this requires taking taxes into consideration so that our loved ones can benefit from every dollar of the life insurance plan.

Income, estate, and gift taxes
Life insurance proceeds payable to a named beneficiary are not subject to income taxes, but may be subject to federal estate taxes. If death benefits are payable to the estate or if the deceased was the policyholder, federal estate taxes will be applied. The estate will also be taxed if its net value is more than the exempt amount set by the government.

The marital deduction exception shifts or postpones any tax burdens for a married couple. One spouse would not be taxed if the other spouse dies. When the surviving spouse dies, the assets in the estate become taxable.

Another approach to minimizing the effect of federal estate taxes is for the policyholder to transfer assets to others during the policyholder’s lifetime. This reduces the estate and any potential estate taxes.

However, this approach must take gift taxes into consideration. A transfer of assets as a gift is subject to a gift tax if the value of the gift exceeds $11,000 annually. Therefore, up to $11,000 can be transferred each year without any gift tax penalties.

A “transfer for value” may also result in taxation, if the policy was transferred for an insufficient amount of consideration. Because the transfer is seen as an attempt to avoid paying the taxes, the benefits become taxable. Timing is also a consideration. If the insurance policy is gifted to another person during the 3 years preceding the policyholder’s death, death benefits may be included in the estate value.

How much is enough?
The amount of insurance needed to protect an estate should be sufficient to cover the estate taxes on assets and any additional taxes enforced due to the amount of life insurance involved. Insurance proceeds increase the gross estate value that is subject to taxation.

AAOS members who are considering the role life insurance will play in their estate plans must take into account their loved ones’ individual needs and goals, as well as any potential tax consequences. For detailed information on the Group Term Life Insurance offerings through the AAOS Member Insurance Program—including a complete list of benefits, limitations, and costs—visit aaosinsurance.com or call 866-679-0888 to speak with an AAOS Member Insurance Program representative.

Erika Wieland is a copywriter for Pearl Insurance, which administers the AAOS Group Term Life Insurance Plan.