How to protect life insurance from estate taxation


Often neglected in the life insurance strategy is the estate tax consequence associated with the ownership and ultimate payout of the insurance policy's death benefit.

Key Points

Q. Are life insurance policies estate taxable?

Life insurance policy owners in this type of situation may want to consider an alternative ownership and beneficiary strategy that completely excludes death benefit proceeds from the insured's as well as the beneficiary's taxable estate. The vehicle used to achieve this goal is an irrevocable life insurance trust (ILIT). When properly structured, the ILIT can be both the owner and the beneficiary of a life insurance policy, without being estate taxable at any time in the future. The trust escapes estate taxation because the insured has no ownership of the policy.

Due to this inherent lack of control, term insurance is often the product of choice when funding the trust. Because term insurance has no cash value, it is purchased for the death benefit only, as opposed to any investment advantages that other types of policies offer.

If an existing policy is transferred to an ILIT, the original policy owner must outlive the transfer by at least 3 years in order to avoid gifting-in-contemplation-of-death rules, which would nullify the tax advantages of the trust (IRC Sec. 2035). If, on the other hand, the insurance policy is owned initially by the irrevocable trust, the 3-year rule does not apply.

There are many more issues that need to be discussed with legal and financial planning professionals prior to implementation. These include the proper use of the $13,000 annual gift exclusion, the income needs of beneficiaries, and transfer limitation rules. These issues should be fully discussed with your advisers prior to applying for coverage.

Q. Is there a 529 plan that guarantees future public college tuition rates?

A. There are two types of 529 plans: prepaid tuition plans and college savings plans. Prepaid tuition plans allow you to lock in predetermined prices for future college tuition costs, but often with restrictions. Prepaid plans may include residency requirements, age restrictions for the beneficiary, and limited enrollment periods. They also may not let you put aside money for other education-related expenses, since many only cover tuition and certain fees.

On the positive side, however, college tuition rates tend to rise faster than the rate of inflation. You can make a one-time lump-sum payment or pay a monthly amount over a specified number of years.

College savings plans tend to be more flexible than prepaid tuition plans. In most cases, the beneficiary is allowed to go to a school in any state. Plus, you can choose how the money is to be invested, using mutual funds, money market funds, or bond funds.

College savings plan funds can be used to pay for "qualified" educational expenses such as room and board, additional fees, books, computers, and other expenses that are directly related to the student's education. Unlike a prepaid tuition plan, the money in a college savings plan may be subject to swings in the market, depending on the investment option chosen.

In addition, you cannot "lock in" costs now and pay that amount, regardless of any price increases.

Joel M. Blau, CFP, is president and Ronald J. Paprocki, JD, CFP, CHBC, is chief executive officer of MEDIQUS Asset Advisors, Inc. in Chicago. They can be reached at 800-883-8555 or

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