When Life Insurance becomes Taxable

August 22, 2023

A life insurance policy benefit is usually paid to the beneficiary in a lump sum, which isn’t taxable. However, there are situations when life insurance becomes taxable.

A life insurance beneficiary may receive the policy amount in installments. If so, the benefit is placed into an account that can accrue interest. While the beneficiary won’t pay taxes on the benefit itself, they’ll be responsible for paying income taxes on any interest accrued.

Fed Manager’s recent article, “When Is Life Insurance Taxable? Four Scenarios to Consider,” gives the example of Jenny being the beneficiary of a $500,000 death benefit that earns 10% interest for one year before being paid out. She’ll owe income taxes on the $50,000 in interest growth.

The death benefit of a life insurance policy is usually paid directly to the beneficiaries named. If the benefit is included in the estate, it’s subject to potential federal and state estate taxes if it is above the tax exemption amount. About a dozen states have state estate taxes with exemptions, so if the death benefit amount is above these exemptions, any amount above the threshold would be subject to estate taxes.

A life insurance death benefit would be subject to taxes in the event of a taxable gift. This happens when three people serve three different roles in connection to the policy:

The policyholder is the individual who bought the policy and is responsible for payment of the premiums
The insured is the person whose life is covered by the policy and
The beneficiary who receives the death benefit when the insured passes away.

Assume that Tommy buys a life insurance policy for his wife, Tilly. They designate their son Teddy as the beneficiary. If Tilly dies and Teddy receives the death benefit, the IRS considers this a taxable gift from Tommy to Teddy because Tommy was the policyholder. In this situation, Tommy may have to pay gift taxes for any benefit amount that exceeds federal gift tax exemption limits.

The annual gift exclusion is $17,000 per individual. The lifetime limit is $12.92 million per individual. (These “numbers” are for 2023 and are adjusted for inflation.) To avoid this, Tilly could purchase and make payments on a policy herself, with Teddy still named as the beneficiary. Work closely with your estate planning attorney and financial advisors to understand when a life insurance policy becomes taxable and how to avoid the unnecessary financial headache. If you would like to learn more about life insurance and estate planning, please visit our previous posts.

Reference: Fed Manager (April 25, 2023) “When Is Life Insurance Taxable? Four Scenarios to Consider”

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Costly Social Security Mistakes to Avoid

August 2, 2023

Social security was created to do just what it’s title intends – to help bring some financial security to seniors beyond retirement age. With so many ways to claim benefits, especially if you are married or were divorced at some point in your life, small mistakes can add up to a big difference in the amount of Social Security benefits you receive, says a recent article, “11 Social Security Mistakes That Can Cost You a Fortune” from Nasdaq. With so many Americans relying on social security benefits to help supplement their lives, there are some costly social security mistakes to avoid.

Not checking your earnings record during your working life can add up to significant losses. Even if you’re decades away from claiming, you should check your earnings record annually since this is what Social Security benefits are based on. Common mistakes include employers recording incorrect earnings or earnings not showing up because you changed your name and the name change wasn’t processed correctly.

Check your statement annually to avoid losing the right number of benefits because of earnings record mistakes. If you see an error, send proof of your earnings to the Social Security Administration. You might submit your W-2 form if you’re a salaried employee or your tax return if you are self-employed. Once the SSA verifies your claim, your record will be corrected. This is a “sooner is better than later” task because you may not have a paper trail going back 30 years.

Another mistake people make is not working long enough. To qualify for Social Security, you need at least 40 work credits. Taxpayers earn up to four credits each year based on earnings. For example, in 2023, you must earn $1,640 to earn one credit or $6,560 to earn four credits. Benefits are calculated based on the average of the 35 highest earning years. If you haven’t worked for 35 years, $0 will be averaged for each year you don’t have earnings.

It’s wise to do the calculations for Social Security before retiring. As you approach your retirement date, check your earnings statement first to be sure you have enough credits to qualify for Social Security. If you don’t have 35 years, consider working another year or two. If you worked at a job where you weren’t paying into Social Security, adding another year of work could ensure you qualify and may also boost your monthly benefit amount.

Taking Social Security too early can take a big bite out of benefits. While everyone eligible can start taking benefits at age 62, for everyone born after 1959, the reduction for benefits at age 62 is 30%. This lower benefit is permanent and won’t increase until you reach Full Retirement Age (FRA). It’s best to wait at least until FRA. If you can wait past FRA, your benefits could increase by as much as 8% per year up to age 70.

Another mistake is waiting too long to claim benefits. If you live to the average life expectancy, it won’t matter if you claim benefits too early or late. The amount of the benefit reduction for claiming early and the increase in delaying a claim evens out. But if you are in poor health or have cash flow trouble, a benefit check at a younger age could be the right move.

If you file for Social Security benefits solely on your earnings record, you might miss out on a larger benefit. Let’s say you were a stay-at-home parent while your spouse worked. You may not have enough work credits to qualify, or your benefits may be small. However, you could still qualify for benefits under your spouse’s work record. Check to see how much you would be eligible to receive under your spouse’s work record before deciding how to claim benefits.

If divorced, you might claim benefits under your ex-spouse’s earnings record if you meet all the requirements. Suppose the marriage lasted at least ten years. In that case, you are 62 or older, unmarried, and your ex-spouse is eligible to receive Social Security retirement or disability benefits. Your benefit from your work is less than what you would receive under your ex-spouse’s earnings record; it’s worth exploring this option.

If you are married, it’s best to coordinate claiming strategies with your spouse. A low-earning spouse could start claiming benefits based on the higher-earning spouse’s income at full retirement age. Meanwhile, the higher-earning spouse delays benefits to increase retirement credits.

Finally, remember that up to 85% of Social Security benefits could be subject to federal income taxes if you earn substantial income from wages or dividends. The percentage of benefits subject to income taxes depends on the couple’s combined income, which includes the household Adjusted Gross Income (AGI), any nontaxable interest income, and half of your Social Security benefits. The best way to avoid these costly social security mistakes it to make sure you are working closely with your estate planning attorney and financial advisor or CPA. If you would like to learn more about social security benefits and estate planning, please visit our previous posts.

Reference: Nasdaq (July 2, 2023) “11 Social Security Mistakes That Can Cost You a Fortune”

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The IRS has issued a Ruling that will impact Grantor Trusts

July 18, 2023

The IRS has issued a ruling that will impact grantor trusts. Completed gifts to grantor trusts will not receive a Section 1014 step-up in basis upon the grantor’s death. According to the IRS, Revenue Ruling 2023-2 concludes this is the appropriate result because such property is not acquired from a decedent for purposes of Section 1014(a) of the IRC of 1986 as amended in Section 1014(b) of the Code, as reported by Reuters in the article “IRS confirms that completed gifts to grantor trusts are not eligible for Section 1014 step-up.”

Upon their death, assets received from a decedent are afforded a basis step-up under Code Section 1014. These are assets usually included in the taxable estate for estate tax purposes. However, before the Ruling, many practitioners wondered whether the assets of an irrevocable grantor trust would be eligible for the same benefit.

The irrevocable “grantor trust” is an anomaly under the Code. A “grantor trust” is not recognized as a separate taxpayer for income tax purposes during the lifetime of the creator (usually referred to as the “grantor” or the “settlor”). All income earned during the grantor’s lifetime is reported on the grantor’s individual income tax returns. However, if the grantor trust is irrevocable and if transfers to the trusts are deemed to be completed gifts, then when the grantor dies, the assets of the grantor trust are not included in the taxable estate of the grantor for estate tax purposes. Thus, the grantor trust is deemed to be owned by the grantor for income tax but not estate tax. This led to uncertainty over the eligibility of the grantor trust assets for the Code Section 1014 basis step-up on the grantor’s death.

“Intentionally defective” grantor trusts are widely used, where the grantor is treated as the owner of the grantor trust for income tax purposes and is responsible for paying the income taxes incurred by the trust. The payment by the grantor of the grantor trust’s income taxes effectively lets the grantor make additional tax-free gifts to the grantor trust and increases the grantor trust’s rate of return.

However, since the grantor trust is not a separate taxpayer for income tax purposes, there’s no recognition of gain on the sale or interest income on the note. The interest rate on the note can be the lowest rate which will not cause adverse tax consequences. If the interest sold to the grantor trust grows faster than the applicable interest rate, the excess growth passes, transfer-tax-free, to the grantor trust.

The “Sale Technique” has been used many times since the IRS released Revenue Ruling 83-15, supporting the position that a property sale from a grantor to a grantor trust is not a taxable event. If no gain is recognized on such a sale, the grantor trust takes a carryover basis in the grantor’s property.

With the release of Revenue Ruling 2023-2, how should estate planning attorneys advise their clients? There are a few strategies to consider:

Power to Exchange Assets. Many grantor trusts allow the grantor to substitute trust property for other assets of equivalent value. If a grantor trust has an asset with a low basis, during the grantor’s lifetime, they could exercise the Substitution Power to exchange the low-basis asset for property with a higher basis but of equal value. The low basis asset now becomes part of the grantor’s estate and, as long as the grantor retains it until their death, will be eligible for the Code Section 1014 basis step-up.

Second Sale to Trust. If the trust agreement establishing the grantor trust doesn’t grant Substitution Power, the grantor could purchase low-basis assets from the trust for high-basis assets. The grantor may engage in a series of sales to ensure appreciated stock continues to cycle back to the grantor, so the estate may take advantage of the Code Section 1014 basis step-up.

Granting a General Power of Appointment. In certain situations, it may be possible to grant a testamentary general power of appointment over a grantor trust to a parent or other elderly relative, the “Powerholder.” The grant of a general power of appointment results in the assets subject to such power being includable in the estate of the Powerholder for estate tax purposes. The trust assets in the Powerholder’s estate will then be eligible for the Code Section 1014 basis step-up upon the death of the Powerholder.

The grant of the general power of appointment should not exceed the Powerholder’s available estate tax exemption and only apply to assets with built-in gain. This strategy will require consideration of the Powerholder’s creditors and any possible risks to the grantor trust.

The IRS has issued a ruling that will impact grantor trusts. These are complex strategies requiring the help of an experienced estate planning attorney. If you would like to learn more about irrevocable grantor trusts, please visit our previous posts.

Reference: Reuters (June 21, 2023) “IRS confirms that completed gifts to grantor trusts are not eligible for Section 1014 step-up”

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Pitfalls of Gifting and Joint Ownership

June 19, 2023

As with many things related to estate planning, do-it-yourself solutions appearing to be fast and easy fixes often become problems for parents and their children. Trying to simplify asset protection by gifting is loaded with risks, says a recent article, “SENIOR SCENE | Pitfalls of gifting and joint ownership of assets” from The Sentinel-Record. There can be many pitfalls of gifting and joint ownership.

Most notably, the laws governing eligibility for Medicaid used for nursing home care require a 60-month “look-back” period, where any transfer of assets for any reason makes the person ineligible for Medicaid benefits up to 60 months or even longer from the date the gift was made.

Secondly, creditors of the person making a gift could claim any transfer was a fraudulent transfer made in an attempt to defeat the rights of creditors to make a claim. Both parent and child could end up in costly, time-consuming litigation over creditor claims.

Third, and perhaps most problematic, is the chance for the child’s creditors to attach the assets in order to satisfy a claim against the child. This could also occur if the child is embroiled in a divorce—the assets could be considered a marital asset by the court.

Gifting assets was a popular estate planning strategy to reduce or eliminate estate taxes in the past. Nevertheless, in light of the very high current federal estate tax exemptions, this is only used for some families.

Another disadvantage of gifting is the transfer of tax cost basis from the parent to the child for capital gains tax purposes. As a result, the child would be forced to pay capital gains taxes on the increase in value from the parent’s tax cost—typically the original purchase price—versus the ultimate sales price.

Contrast this with a child who inherits an asset at death from a parent. When the child inherits the asset at death, the asset receives a step-up in tax basis to its date-of-death value. This is one of the most favorable tax rules remaining, which is lost when gifting during life is used.

Another problem occurs when seniors make assets jointly owned, especially bank accounts. The bank often encourages this, trying to be helpful so the child may pay the parents’ bills. However, by placing the child’s name on the account, the parent may be subjecting their account to potential creditor claims of their children.

In addition, the jointly owned account passes only to the surviving owner, so the estate plan may be circumvented by having the assets in the account pass to the one child rather than passing to all the remaining trust under a will or trust.

An estate plan created by an experienced estate planning attorney can eliminate many pitfalls of gifting and joint ownership. Before making gifts or establishing joint accounts, meet with an estate planning attorney to learn how to achieve your goals, including planning for Medicaid, without putting your assets at risk. If you would like to learn more about asset protection, please visit our previous posts.

Reference: The Sentinel-Record (May 28, 2023) “SENIOR SCENE | Pitfalls of gifting and joint ownership of assets”

You Need to File an Estate Tax Return

June 5, 2023

Even if your spouse has died and left all their assets to you and no estate tax is due, you still need to file an estate tax return. Doing so may save your family significant sums in estate taxes after your death, according to a recent article from Forbes, “5 Reasons You Must File An Estate Tax Return (Even When No Tax Is Due).”

The estate tax is a one-time tax due nine months after the date of death. The federal threshold in 2023 is $12,920,000 for an individual. Many states have their own estate taxes, with thresholds ranging from $1 million in Oregon and Massachusetts to $12,920,000 in Connecticut. Your estate planning attorney can advise which assets are included in calculating this amount. For example, many people are surprised to learn that proceeds from their life insurance policies are taxable on their death, unless the policy is owned in an irrevocable trust.

No estate tax is due if your assets are left to your surviving spouse because of the unlimited marital deduction. You get an unlimited deduction for the assets left to your spouse. Spouses can leave any amount to their surviving spouse tax-free, whether $2 or $2 million. However, there are reasons to file an estate tax return. The law requires it, even if the value of your estate assets is below the filing threshold.

If you’ve done estate planning, your spouse most likely has a trust that will break into various sub-trusts upon her death. As the surviving spouse, you’ll need to fund those trusts and apportion assets to them, which is done through the estate tax return. The estate tax return establishes the value of what those trusts are funded with.

Critical tax elections. When you file an estate tax return for your spouse, you’ll make certain elections to determine what assets are included in your estate when you die.

Tax savings for heirs. If your spouse has not used up all their $12,920,000 exemption, you can lock in their unused portion and port it to your estate tax return when you die. The portability of the deceased spouse’s unused exemption could potentially save your children millions of dollars in estate taxes in the future.

The combined exemption for two spouses is currently $25,840,000. The federal estate tax rate can be as high as 40%. By locking in the unused exemption, you could save more than $5 million in estate taxes that would otherwise be due on your death. Even if your assets are not in the $12 million to $25 million range, this is still smart because your assets could increase in value, and the estate tax thresholds are scheduled to drop to $5 million in 2026 (adjusted for inflation).

More tax savings for grandchildren. If your spouse has yet to use all of their general-skipping transfer tax (GST Tax) exemption, you can lock in their remaining GST Tax exemption. The GST Tax is a 40% tax on assets, if you “skip” your children and leave them directly to your grandchildren or in a trust that will eventually be distributed to them. The amount of GST Tax exemption is the same as the estate tax exemption, $12,920,000 per person in 2023. Therefore, the amount is the same, but they are different taxes.

You need to file an estate tax return to ensure that you have complied with tax law. Work with an estate planning attorney who has experience handling probate and trust administration. If you would like to learn more about the estate tax, please visit our previous posts.

Reference: Forbes (May 10, 2023) “5 Reasons You Must File An Estate Tax Return (Even When No Tax Is Due)”

Intricacies to Consider when using a SLAT

May 30, 2023

Making plans for the events of the future not only saves your family time and money but will also provide peace of mind to you and your beneficiaries, advises the article “Learn about options for estate planning and wealth transfer” from The Tennessean. One of the tools used in estate planning is the Spousal Lifetime Access Trust (SLAT), an especially useful trust now that lifetime exemptions are set to decrease at the end of 2025. There are a number of intricacies to consider when using a SLAT in your estate planning.

No federal estate taxes are owed for individuals with assets up to $12.92 million and married couples with $25.84 million in 2023. However, federal estate taxes are owed at a maximum rate of 40% for any wealth above these amounts.

This is of particular interest right now. The Tax Cut and Jobs Act of 2017 (TCJA) doubled the federal gift and estate tax exemption per spouse, allowing a married couple to exempt up to $25.84 million and individuals $12.92 million. However, this exemption amount will expire on December 31, 2025, decreasing by about half.

It’s a “use it or lose it” proposition right now, so taxpayers who want to take advantage of these historically high exemption levels should consider taking action before the expiration date. One way to do that is with a Spousal Lifetime Access Trust.

A SLAT is an irrevocable trust where one spouse gifts assets to the other beneficiary spouse. The beneficiary spouse may receive distributions during their lifetime, while the SLAT is removed from the gross estate and isn’t subject to estate taxes upon the beneficiary’s death. It’s a valuable estate planning tool, as it permits taxpayers to gift assets while retaining limited access to the funds through their spouse.

If a person gifts assets to an irrevocable trust, they can’t take the assets back or change the terms of the trust. Therefore, they’ve given up control over the asset. However, a SLAT provides indirect access through the spouse, who may receive income and principal distributions from the trust during their lifetime.

A SLAT needs to be properly drafted by an experienced estate planning attorney, and they do come with some risks. For example, if the beneficiary spouse passes away suddenly, the spouse may lose access to their SLAT payouts. If the couple divorces, the spouse may lose access to assets, unless the trust includes a provision stating that the trust benefits current and future spouses, which allows indirect access to be regained after remarrying. In addition, assets held in a SLAT don’t receive a step-up in cost basis upon the donor spouse’s death. This might lead to increased capital gains tax liability for remainder beneficiaries.

There are a number of intricacies to consider when using a SLAT as part of your estate plan. To ensure that the SLAT is appropriate, consult an experienced estate planning attorney. If you would like to learn more about trusts, please visit our previous posts.

Reference: The Tennessean (May 7, 2023) “Learn about options for estate planning and wealth transfer”

Tax Scams Involving Charitable Remainder Annuity Trusts

May 22, 2023

If you are a wealthy family looking into estate planning, beware of tax scams involving Charitable Remainder Annuity Trusts. The IRS has issued a warning about promoters aiming specifically at wealthy taxpayers, advises a recent article, “IRS Warns Of Tax Scams That Target Wealthy,” from Financial Advisor. Charitable Remainder Annuity Trusts (CRATs) are irrevocable trusts that allow individuals to donate assets to charity and draw annual income for life or for a fixed period. A CRAT pays a dollar amount each year, and the IRS examines these trusts to ensure they correctly report trust income and distributions to beneficiaries. Of course, tax documents must also be filed properly.

Some sophisticated scammers boast of the benefits of using CRATs to eliminate ordinary income or capital gain on the sale of the property. However, property with a fair market value over its basis is transferred to the CRAT, the IRS explains, and taxpayers may wrongly claim the transfer of the property to the CRAT, resulting in an increase in basis to fair market value, as if the property had been sold to the trust.

The CRAT then sells the property but needs to recognize the gain due to the claimed step-up in basis. The CRAT then purchases a single premium immediate annuity with the proceeds from the property sale. This is a misapplication of tax rules. The taxpayer or beneficiary may not treat the remaining portion as an excluding portion representing a return of investment for which no tax is due.

In another scam, abusive monetized installment sales, thieves find taxpayers seeking to defer the recognition of gain at the sale of appreciated property. They facilitate a purported monetized installment sale for the taxpayer for a fee. These sales occur when an intermediary purchase appreciated property from a seller in exchange for an installment note, which typically provides interest payments only, with the principal paid at the end of the term.

The seller gets the larger share of the proceeds but improperly delays recognition of gain on the appreciated property until the final payment on the installment note, often years later.

Anyone who pressures an investor to invest quickly, guarantees high returns or tax-free income, or says they can eliminate taxes using installment sales, trusts, or other means, should be dismissed immediately. Beware of tax scams involving Charitable Remainder Annuity Trusts. Your estate planning attorney is well-versed in how CRATs, LLCs, S Corps, trusts, or charitable donations are used and will steer you and your assets into legal, proper investment strategies. If you would like to learn more about charitable giving, please visit our previous posts.

Reference: Financial Advisor (April 24, 203) “IRS Warns Of Tax Scams That Target Wealthy”

Use Estate Planning to Prepare for Cognitive Decline

May 18, 2023

Since 2000, the national median age in the U.S. has increased by 3.4 years, with the largest single year gain of 0.3 years in 2021, when the median age reached 38.8 years. This may seem young compared to the life expectancies of older Americans. However, the median age in 1960 was significantly lower, at 29.5 years, according to the article “Don’t Let Cognitive Decline Derail Well-Laid Financial Plans” from Think Advisor. As we get older, it is wise to use your estate planning to prepare for cognitive decline.

An aging population brings many challenges to estate planning attorneys, who are mindful of the challenges of aging, both mental, physical and financial. Experienced estate planning attorneys are in the best position to help clients prepare for these challenges by taking concrete steps to protect themselves.

Individuals with cognitive decline become more vulnerable to potentially negative influences at the same time their network of trusted friends and family members begins to shrink. As people become older, they are often more isolated, making them increasingly susceptible to scams. The current scam-rich environment is yet another reason to use estate planning.

When a person is diagnosed with Alzheimer’s or any other form of dementia, an estate plan must be put into place as soon as possible, as long as the person is still able express their wishes. A diagnosis can lead to profound distress. However, there is no time to delay.

While typically, the person may state they wish their spouse to be entrusted with everything, this has to be properly documented and is only part of the solution. This is especially the case if the couple is close in age. A secondary and even tertiary agent needs to be made part of the plan for incapacity.

The documents needed to protect the individual and the family are a will, financial power of attorney, durable power of attorney and health care documentation. In addition, for families with more sophisticated finances and legacy goals, trusts and other estate and tax planning strategies are needed.

A common challenge occurs when parents cannot entrust their children to be named as their primary or secondary agents. For example, suppose no immediate family members can be trusted to manage their affairs. In that case, it may be necessary to appoint a family friend or the child of a family friend known to be responsible and trustworthy.

The creation of power of attorney documents by an estate planning attorney is critical. This is because if no one is named, the court will need to step in and name a professional guardian. This person won’t know the person or their family dynamics and may not put their ward’s best interests first, even though they are legally bound to do so. There have been many reports of financial and emotional abuse by court-appointed guardians, so this is something to avoid if possible. An experienced attorney will make sure you are using your estate planning to prepare for cognitive decline. If you would like to learn more about elder care planning, please visit our previous posts.

Reference: Think Advisor (April 21, 2023) “Don’t Let Cognitive Decline Derail Well-Laid Financial Plans”

How an Annuity Beneficiary Works

May 9, 2023

It is important to understand how an annuity beneficiary works. If the beneficiary of an annuity is your spouse, they can take over ownership of the annuity and receive payments under the annuity schedule. The annuity would be tax-deferred, and your spouse would only owe taxes on the distributions when they take them, says Forbes’ recent article, “What Is An Annuity Beneficiary?

However, the rules differ if your beneficiary is someone other than your spouse. A non-spouse has three options when inheriting an annuity:

A lump sum payment. The beneficiary gets the annuity’s remaining value as one upfront payment and must pay income taxes immediately on the lump sum.
Nonqualified stretch, where the annuity payouts—and the required income taxes—are stretched throughout the beneficiary’s lifetime; or
Beneficiaries can withdraw smaller amounts from the annuity during a five-year period after the annuity holder’s death or withdraw the entire amount in the fifth year.

Only the annuity owner can name a beneficiary. However, they can change beneficiaries at any time, provided the annuity contract doesn’t require you to name an irrevocable beneficiary. You can also choose multiple beneficiaries, designating a percentage of the annuity for each person. Annuity contracts also frequently let you designate a contingent beneficiary—a person who will get the annuity payments if the primary beneficiary dies before the annuity owner does.

The choice of beneficiary also significantly impacts how taxes are handled, so taking the time to document your wishes can save your loved ones from problems in the future.

While you aren’t required to name a beneficiary when you purchase an annuity, it’s highly recommended.

Suppose you don’t have a designated beneficiary in the annuity contract. In that case, the annuity must go through probate—the legal process for recognizing a will and distributing the assets within an estate.

These proceedings can be expensive and time-consuming. It could be several months before everything is resolved and the heirs receive their inheritance. An estate planning attorney will help you understand how an annuity beneficiary works and how to ensure your planning addresses your needs. If you would like to learn more about the role of the beneficiary, please visit our previous posts.

Reference: Forbes (Jan. 19, 2023) “What Is An Annuity Beneficiary?”

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Life Estate can be a Cost Effective Option

April 27, 2023

A life estate can be a cost effective option for couples. The person who holds the life estate is known as the life tenant. He or she is entitled to live in and use the properly as they see fit. However, they don’t have the right to sell or transfer the property to someone else.

Realty Biz News’ recent article entitled, “What is a Life Estate and How to Use It,” explains that a recorded deed will reference that a property is a life estate and name the life tenant. Once the life tenant passes away, the property passes to the remainderman—those who will inherit the property after the life estate ends. Let’s look at some of the reasons why someone might want to have a life estate:

Estate Planning. By transferring property into a life estate, the original owner can ensure that the property will pass to a designated beneficiary without probate. It can be particularly useful for people who want to avoid the time, expense and complexity or the probate process.

Asset Protection. The original owner can protect the property from creditors and other potential liabilities by transferring the property into a life estate. This is useful for those in high-risk professions or with significant debts or legal issues.

Family Dynamics. A life estate can also be used to address family dynamics and ensure that everyone is taken care of. For example, a parent might create a life estate to ensure that their adult child can live in the family home for the remainder of their life without giving them outright ownership of the property.

Tax Planning. By transferring property into a life estate, the original owner can reduce their taxable estate and potentially lower their estate tax liability. This can benefit individuals with large estates who want to minimize their heirs’ tax burden.

When a life estate is created, the property is divided into two parts:

the life estate; and
the remainder interest.

The life tenant has the right to use and enjoy the property during their lifetime. The remainderman has the right to inherit the property after the life estate ends.

Remember, with a life estate; the ownership is broken down into possession and ownership. The life tenant has possession and ownership until they pass away; the remainderman has ownership only. When the life tenant passes away, the property passes to the remainderman, who becomes the new owner. The remainderman has the right to sell, transfer, or otherwise dispose of the property as they see fit. Speak with your estate planning attorney to see if a life estate can be a cost effective option for your family’s planning. If you would like to learn more about life estates, please visit our previous posts.

Reference: Realty Biz News (March 20, 2023) “What is a Life Estate and How to Use It”

Photo by Kindel Media

Category: Tax Planning

When Life Insurance becomes Taxable

The IRS has issued a Ruling that will impact Grantor Trusts

Pitfalls of Gifting and Joint Ownership

You Need to File an Estate Tax Return

Intricacies to Consider when using a SLAT

Tax Scams Involving Charitable Remainder Annuity Trusts

How an Annuity Beneficiary Works

Life Estate can be a Cost Effective Option

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