Recently in a seminar I was asked: “Can a beneficiary of my estate pay for the taxes by using my IRA account”?
Those of you who have IRA accounts should know that upon death your estate may be subject to federal estate taxes, and these taxes need to be paid within nine (9) months of your passing. This becomes important because if heirs withdraw money from your IRA to pay estate taxes, then they are subjecting themselves to “income tax” on the withdrawal from the IRA account.
This is definitely not what you want your heirs to do. By taking money from an IRA to pay estate taxes, they cause two problems:
1) Creating another tax on their inheritance
2) Reducing the amount of tax deferred money that you were trying to leave your heirs in the first place.
An irrevocable life insurance trust is a simple strategy you can use to avoid this problem. You can take distributions from your IRA starting at the age of 59 ½. With these distributions, you can then reinvest the “distribution money” into the purchase of a life insurance policy that is held by an irrevocable trust. Basically, you establish an irrevocable trust into which you will make gifts, (by using your gift tax exclusion.) The trust will then buy the life insurance policy on your life. Upon your passing, the proceeds from the life insurance policy will be used to pay your estate taxes, as well as any income taxes on your account.
By using this strategy you establish proper planning for a life insurance policy to pay all future taxes that might be due upon your death. Your heirs can avoid having to come up with the sufficient funds to pay estate taxes due and avoid having to pay any income taxes on the IRA account simply by purchasing the right policy.
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