Life insurance is present in almost every estate plan and serves as a source of support, education-expense coverage, and liquidity to pay death taxes, pay expenses, fund business buy-sell agreements, and sometimes fund retirement plans.
For small estates, the amount of applicable exclusion ($12,920,000 million per person per estate in 2023), and death taxes are not a significant consideration. For this reason, insurance ownership as a tax-savings device is not critical. The main item that policy owners should be aware of is to ensure that the beneficiaries are well provided for by the chosen insurance policy. For larger estates with more assets than the amount of the applicable exclusion of $12,920,000 million, life insurance is an essential component of the estate plan.
Tax Implications of Life Insurance and Your Estate Proceeds from life insurance that are received by the beneficiaries upon the death of the insured are generally income tax-free. However, there are three circumstances that cause life insurance to be included in the decedent's estate:
1. The proceeds are paid to the executor of the decedent's estate.
2. The decedent at death possessed an incident of ownership in the policy.
3. There is a transfer of ownership within three years of death (the hree-year rule must be observed).
An incident of ownership includes the right to assign, terminate, name beneficiaries, change beneficiaries, and borrow against the cash reserves.