One of the biggest headaches for executors of large estates is coming up with the cash to pay the estate tax. If the cash or other liquid assets are not a part of the estate, then other things might have to be sold that the testator would have preferred to have gone to his or her heirs. There is a way to avoid this problem.
Estate law lore is full of stories about things that had to be sold to pay the estate tax. Businesses, art collections, real estate, wine collections and much more have been sold so that money could be made available to pay the estate tax. However, there is a relatively simple way to provide your estate with enough cash to pay the estate tax: life insurance.
This was recently explained in the Wills, Trusts & Estates Prof Blog in "How Life Insurance Can Be Used To Help With Estate Taxes."
You can create an irrevocable trust and make it the beneficiary of a life insurance policy.
When the insurance is paid out, the executor of the estate can use the money to pay any estate taxes owed. It is important that the trust be irrevocable in order for the life insurance proceeds to not be included in the estate and also subject to the estate tax.
For this to work the trust must be created at least three years before you pass away. If not, then it will be considered as part of your estate.
Of course, life insurance is not the only way to provide liquid assets that can be used to pay estate taxes. Before rushing to create an irrevocable trust and buying a life insurance policy, talk to an estate planning attorney about your other options.
Reference: Wills, Trusts & Estates Prof Blog (October 15, 2015) "How Life Insurance Can Be Used To Help With Estate Taxes."