Is life insurance included in an individual’s estate?

Life insurance is a common type of coverage that many Americans take on during their lifetime, especially if they have or are planning to have a family. Life insurance benefits are paid out to family members or beneficiaries in the event of the policy owner’s death, allowing the recipients to cover funeral expenses, pay off debts, create an education fund or simply live off the proceeds. While the proceeds of a life insurance policy are generally free from federal and state income taxes, there are some instances in which the coverage may be included in individual’s estate.

There are a number of rules that govern estate taxes and their treatment of life insurance, so it’s important to know the basics and speak with a seasoned tax preparer to plan accordingly. For example, current tax rules say that if the individual who purchased the policy is considered the owner of his or her own coverage, the proceeds of the benefits are included in that person’s estate, according to SmartMoney.com. However, this circumstance does not apply if the beneficiary of the policy is the owner’s spouse and he or she is a U.S. citizen, the news source explains.

This can create problems, however, if the benefits are to go to a non-spouse, such as a child, parent, sibling or the like. In this case, the benefits may be included in an individual’s taxable estate, and if the total amount of assets - including investments, vehicles, homes and other income - exceed $5 million for 2011-12, the owner’s life insurance may be taxed, the news source reports.

There are some ways individuals may be able to prevent their policies from being included in their estates, and the most common way involves setting up an irrevocable life insurance trust policy, in which case the trust manages the premiums and payouts to the trust’s designated beneficiary, SmartMoney reports.

But individuals should be aware that a number of rules and stipulations are attached to these policies. For example, if a consumer places his or her life insurance policy into an irrevocable trust and passes away within a three-year period, the funds are automatically included in his or her estate, the news source explains. For this reason, speaking with a life insurance agent and tax preparer is recommended to understand the legalities behind these policies and avoid any issues that may arise.

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