One of the biggest advantages of a life insurance policy is the tax benefits it can offer your beneficiaries. Generally speaking, the death benefits of a life insurance policy are not subject to income taxes. With current federal income tax rates topping out at 39.6%, this is an advantage that can lead to substantial tax savings.

However, just because death benefits are often exempt from income taxes does not necessarily mean that the beneficiary will avoid a tax bill entirely. If the deceased is the owner of the policy at the time of passing, the death benefits will be included as part of the estate. This means that those benefits may be subject to estate taxes which currently have a top rate of 40% at the federal level. Most estates will likely be exempt from federal estate taxes as there is currently a $5.34 million exemption. While this is a large amount, it is possible that the exemption limit may decrease in the future, meaning more families may be subject to federal estate taxes in future years.

Perhaps the best solution is to implement an irrevocable life insurance trust (ILIT). An ILIT is specifically designed to hold and own life insurance policies. Rather than naming yourself the owner of your life insurance policy, you would instead name the trust as the owner of the policy.

Establishing an ILIT can allow you to maximize the wealth you will pass on to your descendants. Upon the passing of the insured, the trustee of the ILIT receives the death benefits. The trustee then passes those benefits on to the estate’s personal representative to help pay for various estate taxes and other settlement costs, effectively bypassing federal estate taxation. This method can be an affordable way to for any expenses that occur with the execution of your estate.

It is important to remember that different states have different rules regarding how they handle the taxation of estates. Currently, Iowa does not have an estate tax, so any estate taxes you may need to pay would be handled at the federal level solely. While there is not an estate tax, Iowa does have an inheritance tax. Fortunately, direct descendants such as surviving spouses, parents, grandparents and children are exempt from the inheritance tax.

Before considering an ILIT for your estate plan, keep in mind that any gift made to an irrevocable trust cannot be taken back. You will also lose day-to-day control over how the assets within the trust are used.

Establishing an ILIT is a complicated procedure. Because of the amount of expertise required, I recommend working with an experienced estate planning attorney. Planning ahead can help you fully utilize all of the tax advantages a life insurance policy can offer you and your loved ones.