The old saying “the one thing you can be guaranteed is that death and taxes will be included in your life-plan” is both true and a cruel reality. Death is a part of life: the same can be said of taxes.
It is important to know that while we are all familiar with our annual income tax liabilities, there are three taxes that we need to be familiar with:
Income taxes: the tax you pay on wages earned, or income to your household. You settle up with Uncle Sam annually when you file your taxes.
Gift taxes: In the current year 2010, you are allowed to give as many people you want up to $13,000 per year: if you are a couple, you may “gift split” and give each person $26,000. After that amount is given, and overage would be taxable. However, since there is maximum lifetime exclusion ($1,000,000 for year 2010), you may use your overage to take a credit against your lifetime gifts by filing the appropriate gift tax forms. Consult your tax advisor on this issue is you plan to give a gift in excess of the allowable annual exclusion
Estate taxes: this has been a hot-button for some time. Some say it’s unfair for the government to levy estate taxes, as you paid income taxes on your earnings over the years and if you die with an estate above their limits you get hammered again. Over the past 10 years it has grown from $600,000 to $3,500,000 in year 2009, and is unlimited for 2010, known as the “sunset year” as Congress has not yet determined where it will go from here.
Death taxes or the amount to be paid upon your death by your estate are due and payable in cash within nine months after the taxpayer’s death. It may be paid in a number of ways:
- The executor may borrow the cash: This only defers the problem, since the money will have to be repaid with interest. This includes installment payments to the government.
- The taxpayer may pay in cash: Rarely does a person accumulate large sums of cash. If he or she does, he or she probably will forego many profitable investment opportunities in order to keep the estate in a liquid position.
- The taxpayer may sell stock market investments: This may be a wise choice if the market is “up” when the stocks or bonds need to be converted to cash and the taxpayer has been investing long enough to accumulate the necessary amount.
- The executor may liquidate other assets: If there is not a ready market, however, the assets may be sold at a great loss.
- The taxpayer can pay his or her estate settlement costs with life insurance.
There are advantages of funding your death taxes with life insurance, but keep in mind that the policy must be taken out when you are in good health, and hopefully at a younger age since the older you get, the more the insurance will cost. Some advantages of utilizing life insurance in your estate plan to pay death taxes are:
- The insured’s heirs almost always get back more than he or she paid in.
- Payment of benefit is prompt.
- There is generally no income tax on the proceeds as life insurance proceeds may be free of estate tax.
- Payments can be spread out rather than paid all at once.
- The proceeds are generally not subject to probate.
- Life insurance provides relatively quick cash for a predictable and certain need which will arise at some unpredictable moment due to the settlement of the estate.
Note: Under the Tax Act of 2001, the federal estate tax is gradually phased out until its final repeal in the year 2010. If Congress does not act at that time to repeal it for the years following, it will automatically revert back to the rates in effect during the year 2001, with an exemption for the first $1,000,000 of assets.
