Individuals who acquire a sizable net worth during their lifetime may be subjected to taxes on that net worth at their death. There is a federal estate tax applicable to estates in excess of $600,000. The tax is progressive in nature with a lower rate (such as 38 percent) applicable to smaller estates, increasing to 55 percent for large estates. Federal taxes must usually be paid within 9 months of the owner�s death. This presents a real problem for individuals or families whose most important and largest assets are illiquid forms of investment, such as family-owned businesses and investment real estate. These assets cannot be quickly converted to cash without a significant decrease in value. In most cases the family would prefer to retain the asset and its future income-generating potential. Life insurance proceeds can provide the necessary cash to pay the tax liability and to preserve the assets being taxed for the benefit of family survivors.

Federal gift taxes can also be a sizable tax liability at death. The rates are the same as those for federal estate taxes. They apply to all nonexempt gifts on a cumulative basis. In other words, the aggregate amount of gifts made since 1932 is taken into consideration in determining the applicable gift tax rate for the gifts currently being taxed. For donors in the highest tax brackets the gift tax can equal 55 percent of the value of the gift itself.

The gift tax triggered by the donor�s death often involves gifts that were completed by reason of the death. Examples include jointly owned property after one of the joint owners dies and life insurance proceeds under some policy ownership and beneficiary designation situations. Settlement of the estate may also result in gift taxes due on gifts made shortly before death.

Some states impose estate taxes in addition to the federal estate taxes. These taxes, like the federal taxes, are due within a relatively short period of time and must be paid with liquid funds. Careful planning is required to provide for these state and federal taxes, especially if life insurance is to be the funding mechanism. The policies themselves may in fact be subject to the tax and increase the tax liability being funded by the policy. Good tax counseling can save unnecessary taxes and provide the optimal tax-saving strategy for the family whose objectives and considerations preclude the usual steps to minimize taxes.