Avoid Paying Estate Taxes on a BIG Estate

Here's a little "assurance insurance" strategy that may help minimize the tax hit if you have a large estate worth more than a million dollars–especially if a large chunk of this money will come from your insurance policy. Don't think you're worth a million bucks? Between your home, your life insurance proceeds, your pension and your possessions, you could easily be sitting on a cool million!

So, what to do? The proceeds from a life insurance policy avoid probate if they are left to a named beneficiary. In addition, life insurance proceeds are generally free from federal income taxes. But these proceeds usually get hit with federal estate taxes. There is a way, however, you may be able to avoid estate taxes.

Dolan Smart Money Move: Buy a life insurance policy inside an Irrevocable Life Insurance Trust (ILIT) to avoid estate taxes. A properly created ILIT is the owner and the beneficiary of the life insurance. Because you don't own the life insurance–the ILIT does–the life insurance proceeds aren't subject to federal estate tax.

An ILIT is irrevocable, meaning you can't change it once you've set it up, but it lets you control who gets the life insurance proceeds, and when. In addition, by keeping the proceeds in a trust for your family, the proceeds are free from the claims of creditors or divorce courts in almost all situations. Given our litigious society and the large number of divorces, this benefit is a biggie.

Using this strategy, each time you pay a life insurance premium, you are really making a gift to your beneficiaries. Set up the ILIT so you make the most of your $10,000 annual exclusion for gifts. For example, if you name your three children as beneficiaries of the ILIT, you and your spouse can each gift $36,000 ($12,000 per child) to the trust each year in the form of life insurance premiums. That $72,000 will buy a lot of life insurance!

But what kind of insurance is best? Since there's no way to know who will die first–you or your spouse–we recommend that you buy second-to-die insurance. You see, this type of policy pays only after both you and your spouse die. This should make it less expensive than buying separate policies for you and your spouse.

By planning your ILIT with a good estate planning attorney and a good life insurance agent, you can benefit from one of the best tax savings tools around.

Even the best strategy can become out-of-date, so review your entire estate plan at least every five years–and also anytime you have a major change in your life. In our minds, there's nothing more important for you to do than take action on your estate plan. We hope that none of our strategies are needed anytime soon–but we also want to make sure that your loved ones are left well cared for.

Early estate planning is a crucial part of your financial security. Learn more strategies with these articles:

• The Best Way to Draft Your Will
• Give Away Your Home the Right Way