Naming the right beneficiary

You can significantly reduce your heirs' tax bill by naming the right beneficiary for your life insurance and pension accounts. Yes, the 2001 tax act repealed the estate tax, but the repeal doesn't take effect until 2010. So a person who dies this year can pass up to $1.5 million dollars in assets without paying a federal estate tax. But the addition of life insurance funds could push your total assets over the limit.

To protect your life insurance from estate taxation, don't name your estate as the beneficiary or retain any of the rights of ownership. Instead, make your spouse the beneficiary and owner of your policy. You also need to give up the right to change beneficiaries, assign the policy, pledge the policy as security for a loan, borrow the cash surrender value, or surrender or cancel the policy. These rights, if retained, can pull the insurance back into your estate, making your insurance benefits taxable. And when it comes to buy-sell agreements between business partners, make sure your partner is the owner and beneficiary of your insurance policy.

If you're buying life insurance now, you could make a trust the owner and beneficiary of the insurance. As long as you don't retain any rights of ownership, the insurance won't be open to taxation. But be careful; if you transfer existing policies into a trust, you must live for at least three years after the transfer or the insurance will be thrown back into your estate.