Although death and taxes are inevitable, combined they are even worse.
If you are preparing to leave an inheritance, without proper planning you may also leave an unexpected and super-sized bill to your beneficiaries via the government in the form of “death taxes”. Two separate but related “death taxes”, estate taxes and inheritance taxes, can both be levied and significantly decrease the amount of money and property that you plan to give away at your death.
While you can’t protect yourself from death, in most cases, with proper estate planning, you can protect your estate and your beneficiaries from excessive and unnecessary taxation at your death.
What Are Estate and Inheritance Taxes?
Estate taxes and inheritance taxes are both taxes that are applied on the transfer of property or assets following death. However, they are fundamentally different in how they are applied.
According to the IRS, “The Estate Tax is a tax on your right to transfer property at your death. It consists of an accounting of everything you own or have certain interests in at the date of death.” This tax uses a fair market value for any property when assessing the total value of the estate, otherwise known as the “gross estate”, and includes items such as real estate, securities, insurance policies, and business interests. This assessment of value then leads to a determination of the taxes that are owed for the right to transfer your property to beneficiaries.
On the other hand, an Inheritance Tax is a tax that is levied upon the beneficiary of the deceased. This tax is based on the value of the property that was directly inherited by the beneficiary and must be paid by the beneficiary.
For both kinds of taxes, there are exemptions and tax reductions depending on the value of the estate and the familial relationship between the beneficiary and the deceased.
Additionally, for both taxes it is important to understand that these taxes can exist separately at the federal and state level. In other words, there is a federal estate tax and then a separate state estate tax in several different states. Likewise, although the inheritance tax only exists in a handful of states, if you live in one of those states it is extremely important that you are aware of this tax.
What States Have a Separate Estate or Inheritance Tax?
There are currently 16 states that have a separate Estate Tax, Inheritance Tax, or both. These states are:
- Connecticut: Estate Tax
- Illinois: Estate Tax
- Iowa: Inheritance Tax
- Kentucky: Inheritance Tax
- Maine: Estate Tax
- Maryland: Both
- Massachusetts: Estate Tax
- Minnesota: Estate Tax
- Nebraska: Inheritance Tax
- New Jersey: Inheritance Tax
- New York: Estate Tax
- Pennsylvania: Inheritance Tax
- Oregon: Estate Tax
- Rhode Island: Estate Tax
- Vermont: Estate Tax
- Washington: Estate Tax
The percentage of taxes levied on estates and inheritances depend upon the state, the size of the estate, and the familial relationship between the deceased and the beneficiary. Only 6 states currently levy an inheritance tax as of October 2022.
How Life Insurance Can Help
An irrevocable life insurance trust (ILIT) is a trust that is created while the insured is still living and both owns and controls a life insurance policy throughout the life of the insured. The purpose of an ILIT is to protect both the insured’s estate as well as help the beneficiaries of the life insurance policy. Among the benefits of a establishing an ILIT are:
- An ILIT protects the life insurance policy from estate taxes, minimizing the gross estate tax
- An ILIT can distribute the benefits of the policy upon death as directed by the insured
- An ILIT can be utilized to help pay estate taxes or other debts
- An ILIT can help with avoiding gift taxes and protecting assets and government benefits
Careful planning and consideration must be taken to ensure the rights and inheritance of beneficiaries. If you are interested in establishing a irrevocable life insurance trust, or doing any type of estate planning, it is always best to consult with an experienced and professional estate planning attorney. However, as you will also need a life insurance policy to fund an ILIT, a licensed life insurance provider will also be an essential part of an estate planning team.
CEG Life Can Help
The experienced team at CEG Life Insurance Services understands that estate tax planning can be a confusing experience and is not a do-it-yourself project. Our team is ready to help you and your attorney discuss the life insurance needs of your estate so that you and your family can feel secure in your estate planning.
Contact us to get expert help today with your life insurance needs.