Inheritance Tax Planning Using Life Insurance?

Inheritance tax planning and estate taxes are quickly becoming a growing concern for more and more people around the world. Trillions of dollars are going to be transferred in the coming decades as the generation known as the “baby boomers” pass on their assets to their children, grandchildren, and other beneficiaries. It should come as no surprise that governments all over the globe are fighting (often with each other) to get as large a piece of that pie as they can.

We do not want to get into the political discussion of whether there should or shouldn’t be an estate tax, and if so, at what percentage it should be set at. The fact is, in most countries the estate tax already exists or will come into existence in the future, and people are rightfully concerned.

When people think about planning for inheritance tax, the first words that come to mind are “trust fund”. In some countries and for some people, making use of trusts can be very beneficial. However, in some countries and under some legal systems, trusts either do not provide significant tax benefits, or could even make things worse for you from a tax perspective. There is also the fact that trusts are not easy or cheap to establish, nor are they easy or cheap to maintain moving forward. Further, laws can always change, either invalidating the tax efficiencies of your trust 10 or 20 years down the line, or requiring you to spend more time and money restructuring a new plan.

An alternative to removing assets from your estate via trusts and holding companies is to simply pay the inheritance tax. The problem for your heirs is that this can be difficult, aside from being an expensive and undesirable obligation.

What if a large amount of your estate is tied up in illiquid assets like property or privately owned businesses? How will they sell these assets quickly enough to pay the tax-man on time and without penalty? How bad will their received sale price be in a time-sensitive fire-sale?

The simple solution is to purchase a permanent insurance policy equal to the estimated tax that your heirs will be due to pay upon receiving your estate. For example using easy round numbers, if you anticipate having 3 million dollars in assets upon death, and the inheritance tax blended rate is 33%, your heirs would need to come up with 1 million dollars in cash to pay the tax man. Accordingly, you would need an insurance policy that pays out a 1 million dollar death benefit. If your country of residence taxes proceeds from insurance policies (some do, some do not), then you would need to “gross up” the death benefit.  In other words, you would need an insurance policy that pays out a cash lump sum large enough to pay the taxes on the insurance policy itself, and then the large tax bill on your estate.The best part is, this not viewed by any tax authority as “aggressive tax planning” and requires zero maintenance after set-up. Inheritance tax planning does not have to be complicated. You do not have to concern yourself with the possibility of the tax code changing (which it always does) in a way that invalidates the tax efficiency of your trust or complicated estate planning legal structure.  Going the more technical route and using legal structures to structure your estate you may well become excellent friends with your lawyers who get to enjoy charging fees to advise on and set up new legal structures for you every 10 years, but we would much rather set up a life insurance based inheritance plan once and then not have to worry about it ever again.

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