As the saying goes, there are only two guaranties in life: death and taxes. The whole idea behind purchasing a life insurance policy is to provide for your family in the event of your death. However, whenever money changes hands, the government wants their share.
In some cases, the beneficiaries of your life insurance policy will receive the money tax-free following your passing. In other cases, the proceeds are part of your estate, and therefore subject to taxation, along with your other assets.
What are the instances in which taxation occurs? How can you prevent having your beneficiaries taxed on the money they receive from your life insurance policy? Here is what you need to know in order to ensure that your loved ones receive the greatest benefit from your life insurance policy.
Who Gets Taxed?
In most cases, named beneficiaries of a life insurance policy are not taxed on the money they receive. This is due to double taxation. When someone purchases a life insurance policy during their lifetime, the money used for the purchase has already been subject to tax.
Taxed money paid out by the policy also amounts double taxation. In turn, if the policy holder dies and distributes the money to a named beneficiary, such as a spouse, child, or charitable organization, there is no additional taxation.
However, there are instances where the money from a life insurance policy becomes subject to income or estate tax. If for some reason, the money from a life insurance policy goes into the policy holder’s estate following death, it then becomes subject to taxation. Anyone who inherits from the estate will pay taxes on the money they receive.
The taxing of money really depends on the size of the estate. A smaller sized inheritance will only be subject to income tax. Consequently, insurance from a larger estate is subject to tax at a higher rate.
How to Avoid Taxation
There is good news for anyone who wants to make sure the beneficiaries of a life insurance policy will not be taxed, or suffer any other inconvenience following the death of the policy holder. That is that there are a couple of ways to avoid taxation.
First, you could elect to put the policy in someone else’s name. In this way, it would not become a part of your estate following your death. This is because it is not technically yours. Additionally, it would also place your policy under the control of the new owner. This limits your ability to make changes. Also, it will end up being subject to the gift tax.
An even more beneficial option is to place your life insurance policy in trust. Because this asset holds monetary value, it goes in trust along with other assets like real estate, investments, and so on.
When you pass on, the items held in trust will go immediately to beneficiaries. They are subject to neither taxation nor probate. That is why family trusts are a popular option for passing along inheritance.