Let’s say that Howie passes away and leaves a big estate to his daughter Eva, and there’s an equally large estate tax due. However, most of Howie’s assets are tied up in real estate and in his IRA. With that scenario, Eva might not want to immediately force a sale of the real estate. However, if she accesses the inherited IRA to raise money, she’ll have to pay income tax on the withdrawal and lose a terrific opportunity for extended tax deferral.
FedWeek’s recent article, “Common Mistakes in Life Insurance Designations,” explains that considering this type of scenario, Howie could purchase life insurance on himself.
The proceeds from Howie’s life insurance policy would then be used to pay the estate tax bill. With that taken care of, Eva could keep the real estate, while taking only minimum required distributions from the inherited IRA. If the insurance policy is owned by Eva or by an irrevocable trust (i.e. not Howie or his revocable trust), the proceeds probably will not be included in Howie’s estate and will not increase the estate tax obligation. While life insurance comes to a beneficiary income tax free, it doesn't always come estate tax free. Howie's estate consists of everything he owns. Therefore, if he owns the life insurance it is also subject to estate tax.
That’s a smart way to plan it out. However, some life insurance errors can wreak havoc with an estate plan. Let’s look at some common mistakes:
Naming your estate as beneficiary. This puts the proceeds in your estate—and the money will be exposed to estate tax and your creditors. Your executor will also have more paperwork, if your estate is the beneficiary. Instead, designate the appropriate people or charities. Also, naming your estate instead of you trust could subject the life insurance proceeds to unnecessary probate.
Designating a single beneficiary. Always name at least two contingent or “backup” beneficiaries, which will decrease or eliminate any confusion, if the primary beneficiary predeceases you.
Filing and forgetting the policy. Review your policies every three years. If the beneficiary is an ex-spouse or someone who’s died, make the appropriate change and get a confirmation, in writing, from the insurance company. Also make sure that your successor Trustees/beneficiaries are aware the life insurance policy exists.
Not having adequate coverage. If you have young children, it will take a small fortune to pay for their expenses, including college, in case of your untimely death. Be wise with enough coverage for your children and for whoever will take care of them. It may not or may not be a spouse, but children don’t raise themselves and you don’t want a bargain basement mom for your kids.
While we do not provide life insurance, we will work with your advisor, or refer you to one, to make sure you life insurance works with your estate plan.
One of the main goals of our law practice is to help families like yours plan for the safe, successful transfer of wealth to the next generation. Call our office today to schedule a time for us to sit down and talk about your estate plan, where we can identify the best strategies for you and your family to ensure your legacy of love and financial security. Our office is located in Santa Ana, CA but we serve all of California including Irvine, Orange, Tustin, Newport Beach, and Anaheim.
Reference: FedWeek (February 14, 2019) “Common Mistakes in Life Insurance Designations”