SOMETHING YOU SHOULD KNOW ABOUT ILITS
A lot of people have questions about taxes on insurance proceeds. If you are the beneficiary of a life insurance policy you would not be asked to pay Federal income tax on this influx of financial resources. However, this does not mean that there is no cause for concern with regard to taxation as it applies to insurance policies.
The Federal estate tax is a factor. The life insurance policies that you own are assets that are indeed a part of your estate for tax purposes.
At the present time the estate tax exclusion is $5.12 million, but it is going down to just $1 million in 2013. When the new year arrives the rate is changing as well. It is currently 35%, but it is going up to 55%.
So, if you expect to live beyond the end of this year and your resources, including the payouts from your life insurance policies, exceed $1 million your estate is potentially subject to the estate tax.
As a response you could place your insurance policies into an irrevocable life insurance trust. In this manner you do not own the policies personally so they are not part of your estate in the eyes of the tax man. But, your beneficiaries can still utilize the assets in the trust.
What you should know about these trusts is that there is a three-year waiting period. If you placed policies that you already owned into the trust within three years of your passing they would still be considered part of your taxable estate.
This is why a good San Bernardino estate planning attorney would recommend that you create the trust in advance of purchasing the policies. You could then have the trust purchase the policies and this waiting period would not be applicable.