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For Central Texas families, estate planning involves protecting assets. Life insurance is a powerful tool, typically income tax-free, but its payout can trigger federal estate tax. This paradox is a complex problem we help clients resolve. Our goal is simple: ensure life insurance provides security, passing directly to heirs and shielding them from probate delays and estate taxes.
The Core Problem: Policy Ownership in Texas
Determining the policy’s owner when you pass away is the primary step to avoiding a tax issue. If you, the insured, own or retain any “incidents of ownership,” the IRS includes the entire death benefit in your taxable estate.
Incidents of ownership are broadly defined rights, such as the power to name beneficiaries, pledge the policy for a loan, or surrender the policy for cash. If you bought the policy, you likely hold these powers.
While the current federal estate tax exemption is substantial, life insurance can increase the value of the estate and for many families push it over the exemption amount. The critical and impending change means many more Central Texas families will find wealth, including large life insurance payouts, subject to this federal tax. This federal rule presents the primary financial danger since Texas does not levy a state estate tax.
The Community Property Complication
Texas’s community property laws make life insurance planning tricky. Under the Family Code, assets acquired during marriage are typically community property (Texas Family Code, Sec. 3.002).
This rule extends to life insurance policies. The policy is deemed a community asset if premium payments come from marital income.
This ownership structure sets a trap. If one spouse holds the policy and uses community money for premiums, as much as half the payout may be counted in the first spouse’s taxable estate. More commonly, the full value ends up in the surviving spouse’s estate, leading to an unwarranted tax bill for the heirs. Simply naming a beneficiary is insufficient to bypass this estate inclusion.
The Solution: An Irrevocable Life Insurance Trust (ILIT)
A very effective strategy for integrating a life insurance policy without triggering estate taxes is the Irrevocable Life Insurance Trust (ILIT). This trust is a distinct legal entity designed solely to own life insurance.
The trust, not the insured person, owns and holds all incidents of ownership. The death benefit is successfully removed from the insured’s taxable estate when the trust owns the policy. This simple shift in ownership can preserve millions for your heirs as the insurance proceeds won’t count as part of the decedent’s estate.
The Texas Insurance Code confirms that an individual can designate a trustee as the policy beneficiary (Texas Insurance Code, Sec. 1104.021). Upon the insured’s death, the trustee collects the tax-free proceeds and manages those funds according to your established terms.
ILIT Benefits for Your Legacy
An ILIT offers three critical benefits for Waco, Georgetown and Central Texas families:
- Estate Liquidity: The proceeds can give your estate the cash to pay any remaining taxes or debts, preventing the forced, quick sale of valuable assets like a family farm or business.
- Asset Protection: Funds held within the trust are shielded from a beneficiary’s creditors, lawsuits, or divorce claims.
- Controlled Distribution: You dictate exactly when and how the funds are paid to your children or grandchildren, which is essential for minors or beneficiaries with special needs.
Key Implementation Steps
Creating an ILIT requires precision because it is irrevocable; you cannot easily change or terminate it. We focus on two key decisions.
First, you must choose a trustee. You cannot serve as your own trustee; this would be an incident of ownership. We help clients appoint a trusted family member or a corporate trustee who can competently carry out the fiduciary duties.
Second, the trust must be adequately funded. Money transferred to the trust for premium payments is considered a gift. To use your annual federal gift tax exclusion, ILITs must include a “Crummey power.” This provision gives the beneficiaries a temporary right to withdraw the gifted funds, satisfying IRS requirements. These yearly procedures must be executed appropriately.
Specialized Counsel for Waco and Georgetown Families
Integrating life insurance into your plan requires a command of federal tax law and the specific statutes governing community property and trusts in Texas. Specific and detailed knowledge is essential for preserving generational wealth for Central Texas families.
At Rainey & Rainey, PLLC, Attorneys at Law, our focus is on elder law and estate planning. We do not practice in any other area. This singular focus ensures we are consistently informed of the most up-to-date state and federal law changes. Clients can trust our advice is grounded in current, highly experienced knowledge specific to their planning needs.
We also believe in precise, financially transparent planning. Once we understand your specific goals, we typically work with a flat-fee structure. You walk away knowing the full cost of the legal work required to secure your family’s legacy, providing certainty and peace of mind.
Do not wait for the 2026 tax changes to finalize your plan. We are ready to help you ensure your life insurance delivers its full, tax-free value.
We invite you to contact us at our Waco or Georgetown offices. Call our Waco office at (254) 752-8644 or our Georgetown office at (512) 598-9005.
