When you buy life insurance policies, you want that money to go to your family members — not the government — if you pass away. However, there are ways in which the government manages to tax even these policies.
This is done by counting the money from the policy as part of your overall estate. Therefore, it can be taxed along with the rest of the estate.
Since the federal exemption limit is $5,430,000, smaller policies may not end up being taxed directly. However, what if your policy is for $5,000,000? Though that is still under the exemption line, you have to remember that the exemption is for your whole estate. Therefore, this pushes you closer and perhaps over the line.
Think of it this way: If your estate is worth $5,000,000 and so is your policy, they would both be under the line on their own. However, since they are being combined, the first $5,000,000 is eaten up just by your policy itself. This pushes an estate that would have been under the limit up over that limit, which subjects it to taxes.
There is one way to get around this, and it involves using an Irrevocable Life Insurance Trust, which is usually called an ILIT. The purpose of it is to contain such a policy, helping you pass the ownership on to your heirs through the trust. Doing this means that it does not count any longer as your personal estate, which keeps it from being taxed with everything else.
If you want to do this, make sure you know what is legally required to set up a trust in New York.
Source: FindLaw, “The Irrevocable Life Insurance Trust” accessed Jan. 30, 2015