State Life Insurance Tax

[MrsIMDoc]

I learned something new today.  We were planning to meet with an estate lawyer to set up guardian paperwork and a trust for our child we are expecting this year.  I started to do some research to ask questions for the lawyer and I found out that my state, Washington, has one of the highest estate taxes that includes life insurance. So for a $2 Million policy that would mean a tax of $240,000! 

Has anyone else heard of this?

[MrsIMDoc]

It is income tax free but in our state it is included in the estate of the deceased regardless of the beneficiary and the state (not federal) estate tax would apply. I am hoping I am missing a loophole (that is why we are going to an attorney) but this was definitely news to me.

[MrsIMDoc]

My understanding is that we set up a revocable trust that would only become irrevocable if we both die and then our child would have both life insurances (total $3 million).  My bigger issue is that if one of us dies then the other is not receiving as much life insurance as planned with a large portion going to the state taxes.

Again I have not met with the lawyer yet so if anyone wants to correct me I am happy to hear it.

[pulmdoc]

Life insurance proceeds are not taxed per se, but can count against estate tax exemption. This is an issue only if your assets+life insurance would exceed the exemption. Tax attorneys will advise an ILIT (irrovacable life insurance trust). This makes the life insurance policy in a trust and therefore not part of the estate. However, it requires paying an attorney to make the trust as well as extra paperwork on an ongoing basis. Before doing so, figure out if you truly need as much life insurance as you have; after all, if you have a 5M estate, your heirs are likely financially set even if you don't have any life insurance.

Also keep in mind that estate taxes are not levied on the entirety of the estate, but only on the amount of the estate above the exemption. As an example, a 40% estate tax on a 6.27M estate is 40% × (6.27M-5.27M)=$400,000. Another uncertainty to factor into decision making is that Republicans have wanted to repeal the (federal) estate tax for years, so there's the possibility of all the tax planning being for naught.

[MrsIMDoc]

pulmdoc wrote:

Life insurance proceeds are not taxed per se, but can count against estate tax exemption. This is an issue only if your assets+life insurance would exceed the exemption. Tax attorneys will advise an ILIT (irrovacable life insurance trust). This makes the life insurance policy in a trust and therefore not part of the estate. However, it requires paying an attorney to make the trust as well as extra paperwork on an ongoing basis. Before doing so, figure out if you truly need as much life insurance as you have; after all, if you have a 5M estate, your heirs are likely financially set even if you don’t have any life insurance.

Also keep in mind that estate taxes are not levied on the entirety of the estate, but only on the amount of the estate above the exemption. As an example, a 40% estate tax on a 6.27M estate is 40% × (6.27M-5.27M)=$400,000. Another uncertainty to factor into decision making is that Republicans have wanted to repeal the (federal) estate tax for years, so there’s the possibility of all the tax planning being for naught.

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The big difference that I was unaware of was my state tax (Washington) starts taxing at $1M estates, ranging from 14-19%.

http://dor.wa.gov/Content/FindTaxesAndRates/OtherTaxes/tax_estatetaxfaq.aspx#whatis

[pulmdoc]

Good news, it's not as bad as you think. Reading the link, the estate exemption for 2017 is 2.129M. Then it's 10% tax for the next 1M above the exemption threshold, then it goes up from there. It's still pretty punitive though.

[MrsIMDoc]

Rex wrote:

Hopefully you are just buying term.

You will likely be better off just buying a slightly larger term life insurance policy to pay the additional estate tax if necessary.

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Yes just buying term.  I agree with buying the slightly larger policy, I just was surprised to learn about it.  I am also surprised that the life insurance sales agent did not try to "upsell" me with this in mind.  I would think they would use that in their calculation of how much life insurance you need.

[jfoxcpacfp]

To correct/enhance upon some of the information above:

• Life insurance proceeds are not taxable for estate tax purposes if they are not owned by the insured. This can be accomplished with an ILIT (which is an irrevocable trust) or by changing the owner of the policy to someone other than the insured or the estate. Your agent will be quite familiar with how to accomplish this.


• All assets in a revocable trust are included in your estate at death. A revocable trust has some use but, in my experience, not as much as they are sold to have. Iow, probate is not the nightmare for 99% of the decedents that it is made out to be.


• The likelihood of federal estate taxes at the death of most of the folks reading this blog (in your 30s) is relatively low as of today. Of course, no way to predict the code in 60 years today, but we just ran scenarios for a $19M estate (future) and no estate taxes were owed. This is due to the scheduled annual increase in the estate tax exemption, which is often overlooked.

While federal estate taxes are not your concern today, they will be later. WA residents are some of the highest taxed in the country. Relatively few states still have estate or inheritance taxes (they are 2 different taxes). We have clients looking to move out at retirement. Hopefully, either your state's tax code or your state of residence will have changed by your deaths.

[Craigy]

You should discuss these items with your estate planning attorney.  There is some bad information in here.  Your estate attorney should be able to provide you with the items you should consider and the answers specific to your situation.

Federal vs state law, specific language of the trust, etc. varies tremendously.  There is no one-size-fits-all approach or FAQ when it comes to the potential complexity of estate planning.