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Take these steps to avoid life insurance taxes

Are you looking for a way to transfer your some life insurance proceeds to your heirs without subjecting it to taxation?

There are a number of ways to do it. There are also some fairly common mistakes that could cost your heirs plenty.

1. Do not make your insurance policy payable to your estate.

When you pay the money out directly to an heir, you avoid sending it through the probate process -- which means that you reduce the value of your overall estate (and its tax liability).

2. Transfer policy ownership to someone else.

If you retain ownership of your policy at death, the proceeds can be taxed even if they're paid directly to one of your heirs. However, if you are not the owner, it isn't taxable (as long as you ceased being the owner three full years prior to your death).

There's a caveat to this, however. The owner has to make the policy's payments. If your policy isn't paid up, you can give the owner (who is probably one of your heirs or the named beneficiary) the money to cover the premiums -- as long as the money amount falls below the annual gift tax level.

Keep in mind, however, you lose all right to change anything about the policy once you've transferred ownership. The newly-designated owner would now have that power -- which could be another concern.

3. Establish a trust for the insurance proceeds.

An irrevocable trust for the life insurance policy is another medium that can prevent taxation. You cease being the owner of the policy once it is transferred to the trust, which means the money won't be included in your estate once you're gone.

The trustee can make sure that premiums are paid -- which may be important if your heirs are either minors, disabled or have financial problems that concern you. This might also be a good medium to use if you want to split the proceeds between your heirs but don't want to name one of them the owner out of concerns of jealousy or mistrust. While you can't change the policy's terms, neither can anyone else.

For more information on how to avoid estate taxes, consider some professional advice. There are often more ways to accomplish your goals than you realize -- but it takes specialized know-how to do it.

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