How life insurance can save your heirs a bundle

Do you know what's included in your taxable estate? If your heirs have to pay estate taxes, they may not have the cash to pay the bill without selling off some assets first.

"People need to start thinking about estate taxes if they're accumulating any type of wealth," says Marvin Feldman, president and CEO of the LIFE Foundation, a Washington, D.C.-based nonprofit organization that helps educate consumers about insurance.

Purchasing a permanent life insurance policy and designating your heirs as beneficiaries is one way to provide cash that your heirs can use to pay such taxes. By doing so, you can help loved ones avoid having to sell off the assets in your estate in order to pay the tax bill.

Calculating the tax

Your taxable estate includes the money in your retirement and bank accounts. It also includes the value of your home, autos, artwork, business interests and life insurance policy.

"Anything you own in your name can be taxable," Feldman says.

The total value of your assets that exceeds the federal estate tax exemption -- $5 million in 2011 - is taxed, says David Weinstock, a principal at Weiser Capital Management in New York.

Your heirs probably won't have to worry about federal taxes if you die this year and your estate is worth less than this amount, he says.

Beyond the exemption, your heirs will be taxed at the federal estate tax rate of 35 percent of the value of the estate, says Weinstock. (You can generally leave assets to your spouse tax-free, he says.)

However, unless Congress acts, the exemption is scheduled to be reduced to just $1 million at the end of 2012. To make matters worse, the top estate tax rate will jump to 55 percent.

Do you think your estate will be worth at least $1 million before you die? Add up the value of your home, business interests and payout amounts of any life insurance policies you already own, and the total may surprise you, says Weinstock.

"People often have more wealth than they think," he says.

Even if you don't think your estate's value will be worth more than $1 million, it could still be subject to a state tax bill. That's because some states have estate or inheritance taxes and the exemptions may be lower. For example, New Jersey currently has an estate tax with an exemption of $675,000, says Weinstock.

Consult with an estate planning professional to determine if there are estate taxes in your state, he says.

How life insurance can help

If you leave a sizable inheritance, you may think a tax bill will be no problem for your heirs. After all, money invested in stocks and bonds should be sufficiently liquid to allow heirs to sell and pay any tax bill.

But if the economy is sluggish, you may not leave your beneficiaries with as much of an estate as you had hoped, says Feldman.

"It could be a very inopportune time for an heir to be liquidating stocks and bonds if the market is extremely depressed, because they're selling at the bottom," he says.

And if your property can't easily be converted into cash, your heirs may have trouble coming up with any payment at all, says Weinstock. This commonly occurs when an estate's value is mostly wrapped up in a non-liquid asset, such as a home, family farm or business, he says.

Heirs only have nine months to determine and pay the amount of taxes owed, Weinstock says. To pay the bill, "they may be forced to sale a home or business, or borrow money," he says.

Buying a whole life insurance policy can prevent your heirs from ending up stuck with a big tax bill and no way to pay it. Your heirs simply use the cash proceeds from the policy to pay the tax bill.

It's important to consult a qualified estate planning adviser before making a purchase decision, because there are tax issues to consider, Feldman says.

For example, if you own a life insurance policy in your name, the proceeds would be included in your estate for federal tax purposes. In such cases, those proceeds could be subject to the estate tax, Feldman says. But there are ways to minimize the tax burden.

"You could have an insurance policy issued in the name of a trust," Feldman says.

If the trust is structured properly, insurance proceeds could go into that trust without increasing your estate tax. Your heirs could then access the funds and use the proceeds to pay estate taxes, says Feldman.

The original article can be found at Insurance.com:How life insurance can save your heirs a bundle