Most people know about life insurance. If you don’t, here’s a quick summary of what you need to know. Life insurance is a contract between you as the buyer of a policy and the insurance company where the insurance company will pay a sum of money to your beneficiary (the person you designate to receive the proceeds of your life insurance policy) when you die. The beneficiary can be your spouse, your children, or your business partner, or whomever you want to receive the money when you die.
If you are a young, married man or woman, you need enough life insurance to support your family in the event you die early. You would need enough money to pay for your children’s college tuition, for a retirement fund for your spouse, and for the normal expenses of living – mortgage, utilities, food, car, gas, etc. Typically, that amount can be $500,000 or even $1,000,000 (it’s not cheap living in New Jersey).
How does a life insurance trust enter into the picture? A life insurance trust provides a means of avoiding estate tax. Although you may be aware that the federal estate tax kicks in above estates of $3,500,000 (if you die in 2009), New Jersey has a state estate tax that starts with estates of more than $675,000. If you have some equity in your house, a retirement account, and a bank account, you might be over the $675,000 threshold. In that case, you would be a good candidate for some tax planning. Let’s say you bought a $500,000 life insurance policy and made your estate the beneficiary of your policy. Now, the $500,000 is considered part of your estate for estate tax purposes. If you own a house with $200,000 in equity, have $50,000 in your retirement account, and $10,000 in the bank and add in the proceeds of the life insurance policy of $500,000, you will die with an estate of $760,000. Your federal estate tax is $0 but your NJ estate tax is just under $21,000. Do you want to give away almost $21,000 to the state? If you die 5 years from now, it is more likely that your estate will be larger (hopefully you saved more money and the real estate market went back up a bit). Then you will owe more estate tax.
If you put the life insurance policy in a trust, and you don’t own it anymore, then your estate is worth only $260,000. Your federal estate tax is $0 and your NJ estate tax is $0. That’s why you might need a life insurance trust.
You should talk to an estate planning lawyer to learn about whether you owe any federal or New Jersey estate tax. Would you spend $3,000 to save $21,000?
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