Pay Estate Taxes with Life Insurance

Federal estate tax

The Federal estate tax is imposed "on the transfer of the taxable estate of every decedent who is a citizen or resident of the United States." The starting point in the calculation is the "gross estate." Certain deductions (subtractions) from the "gross estate" amount are allowed in arriving at a smaller amount called the "taxable estate."

The "gross estate" for Federal estate tax purposes often includes more property than that included in the "probate estate" under the property laws of the state in which the decedent lived at the time of death. The gross estate (before the modifications) may be considered to be the value of all the property interests of the decedent at the time of death. To these interests are added the following property interests generally not owned by the decedent at the time of death:

the value of property to the extent of an interest held by the surviving spouse as a "dower or courtesy"[3];
  • the value of certain items of property in which the decedent had, at any time, made a transfer during the three years immediately preceding the date of death (i.e., even if the property was no longer owned by the decedent on the date of death), other than certain gifts, and other than property sold for full value[4];
  • the value of certain property transferred by the decedent before death for which the decedent retained a "life estate", or retained certain "powers"[5];
  • the value of certain property in which the recipient could, through ownership, have possession or enjoyment only by surviving the decedent[6];
  • the value of certain property in which the decedent retained a "reversionary interest", the value of which exceeded five percent of the value of the property[7];
  • the value of certain property transferred by the decedent before death where the transfer was revocable[8];
  • the value of certain annuities[9];
  • the value of certain jointly owned property, such as assets passing by operation of law or survivorship, i.e. joint tenants with rights of survivorship or tenants by the entirety, with special rules for assets owned jointly by spouses.[10];
  • the value of certain "powers of appointment"[11];
  • the amount of proceeds of certain life insurance policies[12].
The above list of modifications is not comprehensive.

As noted above, life insurance benefits may be included in the gross estate (even though the proceeds arguably were not "owned" by the decedent and were never received by the decedent). Life insurance proceeds are generally included in the gross estate if the benefits are payable to the estate, or if the decedent was the owner of the life insurance policy or had any "incidents of ownership" over the life insurance policy (such as the power to change the beneficiary designation). Similarly, bank accounts or other financial instruments which are "payable on death" or "transfer on death" are usually included in the taxable estate, even though such assets are not subject to the probate process under state law.

Year Exclusion
tax rate
2001 $675,000 55%
2002 $1 million 50%
2003 $1 million 49%
2004 $1.5 million 48%
2005 $1.5 million 47%
2006 $2 million 46%
2007 $2 million 45%
2008 $2 million 45%
2009 $3.5 million 45%
2010 * Repealed * 0% *
2011 $1 million 55%
* See paragraph in this section
  with respect to reinstatement
  of this exemption

As noted above, a certain amount of each estate is exempted from taxation by the federal government. Below is a table of the amount of exemption by year an estate would expect. Estates above these amounts would be subject to estate tax, but only for the amount above the exemption.

For example, assume an estate of $3.5 million in 2006. There are two beneficiaries who will each receive equal shares of the estate. The maximum allowable credit is $2 million for that year, so the taxable value is therefore $1.5 million. Since it is 2006, the tax rate on that $1.5 million is 46%, so the total taxes paid would be $690,000. Each beneficiary will receive $1,000,000 of untaxed inheritance and $405,000 from the taxable portion of their inheritance for a total of $1,405,000. This means that they would have paid (or, more precisely, the estate would have paid) a taxable rate of 19.7%.

As shown, the 2001 tax act will repeal the estate tax for one year—2010—and then readjust it in 2011 to the year 2002 exemption level with a 2001 top rate.

On April 2, 2009, the Senate agreed on S.AMDT.873, an amendment to S.CON.RES.13, a non-binding concurrent resolution setting forth the congressional budget for FY 2010, which was later passed. If enacted in the FY 2010 budget, a new $5,000,000 exemption level will be created with a maximum tax rate of 35%.

This will help you calculate how much coverage to buy (to pay for estate tax):

Total Worth

Total Due in $

% Rate


2nd to die buying tips:

Buy your second to die policy in an irrevocable life insurance trust so the proceeds are not included in your estate and thus escape both estate and income taxes
Consider transferring ownership of your survivorship policy to another person NOW. Policy transfers made within 3 years of death are void for federal inheritance and usually state tax purposes
Survivorship life is also beneficial if one spouse is in poor health. It can also be much cheaper than two separate whole life policies because you are waiting longer to get the payout Only name charities as a beneficiary of your retirement plan, IRA, savings bonds, unpaid bonuses, lottery winnings, and unpaid rental income. When you die, the charity will still get the amount you want them to have, and your heirs will not have to pay income tax given from cash or cash equivalents.
Revise your trusts and named beneficiaries, to take full advantage of the gradual increases in the estate tax exclusion, recently enacted.
If your will has a specific dollar amount named, (which many did before 1997), change it too read that the exemption or "marital unified credit" should be in force up to the maximum allowed by law.
Carefully plan gifts, as your recipients will not receive a stepped up basis, as they would for transfers at death.
Consider contributing up to $50,000 into a child's 529, or college education savings plan (keep abreast of the current legislation on this one).
Create a Family limited partnerships or FLIP, which allow you to give away assets now and discount the value for gift tax purposes.

Summary The estate tax has been called a voluntary tax because of the myriad opportunities available to either reduce it or eliminate it completely. If you can't completely get rid of your estate tax, Second to die life is a great way to pay for them. Second to die doesn't have the expiration or get ultra expensive in the later years like term life. You may consider over funding the policy so that with enough cash value, the payments can be made internally from the interest in the insurance policy. As with most insurance, the death benefits can be paid without federal or state taxes, or the costs and delays of probate. Since your second to die policy shouldn't be going through probate, or be subject to estate taxes, it's confidential and can't be challenged by long lost relatives.

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