Leveraging Life Insurance for Kentucky’s Complicated Inheritance Tax

If you live in Kentucky, there’s good and bad news when it comes to estate planning. The good news is that Kentucky doesn’t have an estate tax. The bad news is that the state does levy an inheritance tax. An inheritance tax is pretty similar to estate tax. What mainly changes is who has to pay the tax when you pass away.

Kentucky currently charges this inheritance tax as a cost for receiving property from an estate. Thresholds are low, taxes are high, and the calculation to pay this tax is complicated. As a resident of Kentucky, then you’ll probably want to look into alternative ways of leaving money to beneficiaries.

What You Need to Know About Kentucky Inheritance Taxes

The first thing you need to know about Kentucky’s inheritance tax is that it’s not the estate that pays. It’s the beneficiary. Amounts from $500 to $1,000 and above may be taxable depending on the recipient. The tax can go anywhere from 4% to 16%, though the state does offer a 5% discount if you pay within nine months of the date of death.

How much tax will be paid depends on the relationship with the beneficiary. In Kentucky, beneficiaries are broken into three classes with different exemptions and tax amounts. The three categories are laid out in the table below.

Class A Class B Class C
Spouses Nieces/nephews All others not listed
as Class A or B
Children Half Nieces/nephews
Grandchildren Daughter/son-in-law
Parents Aunts/uncles
Siblings Great-grandchildren
Tax rate: Exempt  Tax rate: 4% to 16%
Exemption: $1,000
Tax rate: 6% to 16%
Exemption: $500

The beneficiary only has to file a tax return if his or her inheritance is considered taxable. The state of Kentucky considers a wide range of items taxable, including:

  • Real estate
  • Cash
  • The value of all bank and investment accounts
  • Life insurance payable to the insured or estate of the insured
  • Annuities
  • Household goods and personal property
  • Royalties
  • Jewelry and antiques

Pretty much anything you pass on to an heir who isn’t a Class A recipient is going to be considered taxable, which means that you’re going to need to get an estate settlement strategy in place. Using life insurance, trusts, and other tactics can help to reduce the burden for your heirs.

Starting the Kentucky Inheritance Process Early

The first thing we suggest is if you have a piece of property in Kentucky that you’d like to give to someone, your best bet is to gift it now. If the item is worth less than $14,000, which is the amount you’re permitted to gift annually, the person receiving the gift won’t have to pay any taxes at all. If that isn’t feasible, then you might want to consider a trust.

An asset protection trust can hold items outside of your estate. One common choice is the irrevocable life insurance trust (ILIT), which is designed to pay out to beneficiaries outside of your estate. Here are some of the benefits of using an ILIT:

  • Life insurance proceeds are held outside of the insured’s name, meaning they are not taxable.
  • The trust protects assets that you want to leave to friends and business partners, who are considered Class C beneficiaries.
  • You can leave funding for individuals to pay taxes on large estate properties.
  • You can prevent creditors from attempting to collect on unpaid debts, as the trust protects the proceeds.
  • The trust is funded with cash value life insurance, which allows flexibility in both premiums and payouts.

At Howard Kaye, we use ILITs as part of our legacy planning process so our clients can create wealth to protect their beneficiaries while minimizing taxes. In some cases, we’ve been able to discount estate tax costs up to 90%. For more information on our estate tax planning strategies, contact us today at 800-DIE-RICH.

Source: A Guide to Kentucky Inheritance and Estate Taxes: General Information. Frankfort: Inheritance and Estate Tax Section, Kentucky Revenue Cabinet, 2000.Revenue.KY.gov. Kentucky Dept. of Revenue. Web. < http://revenue.ky.gov/Documents/92F101714.pdf>