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Buying Life Insurance to Pay for Estate Taxes

After you die, having to pay estate taxes can be a burden that substantially reduces the value of the inheritance you leave your family. If you have worked hard to leave a financial legacy for your loved ones during a period in which they will be struggling to cope with your death, then you should think hard about obtaining adequate life insurance to pay for your estate taxes, or find alternative means to ensure your loved ones obtain the inheritance they deserve. In your later years, think of the peace of mind you will have knowing that your family will be getting what you—and not what the taxman—wants!

If you own a very large estate then federal estate taxes may be as much as 55%! This means that an estate worth $10 million will be taxed so that your loved ones receive only $4.5 million. The taxman takes $5.5 million! So what can you do to prevent your family not receiving what they are due?

One option is to plan ahead and work out how much life insurance will be required so that they receive the amount that you want them to. Essentially, this will mean that with a large estate, you will have to take out a very large life insurance policy, but the consequences may justify this. If we take the previous example, if you had a $2.5 million life insurance policy, and it is invested and grows into a value of $10 million, then the value of your estate is now the initial $10 million, plus the $10 million value of the life insurance, minus the $2.5 million life insurance premium, which equals $17.5 million. If you then die, your family receive 45% of $17.5 million – nearly $8 million. This is far closer to the $10 million initial value of your estate than the $4.5 million they would have received had you not taken out the life insurance policy.

You should, however, consider alternatives to this arrangement, because the downside to buying such a large amount of life insurance is that you will spend much on fees and commissions to the insurance firm. Remuneration will not only be taken in the year in which you take out the policy, but also from subsequent ‘tails’.

You might deal with this by ensuring that you get ‘Private Placement Life Insurance’, which generally saves you money from pay commissions, and should make sure you obtain lower fees than those you would get by using a life insurance agent.

An alternative to this is to establish a ‘captive’ insurance company yourself. These are instrumental companies which may be established only to handle your restricted risk. It is legal to set them up and they are increasingly well recognised as important components of the international life insurance industry. Although they are not immune from tax, establishing them in offshore financial centres can further reduce tax burdens. Talking to an expert financial advisor who has dealt with high net-worth clients in the past is advisable, and can help steer you through the process of ensuring your loved ones get the inheritance they deserve.