Federal Estate Tax on Life Insurance and Retirement Accounts

Federal estate tax on life insurance and retirement accounts works the same way it does on any other asset: the full value goes into your gross estate, and the estate owes tax only on what exceeds the exemption. For 2026, that exemption is $15 million per person, or up to $30 million for a married couple using portability. Above the line, the rate climbs to 40%. Naming a beneficiary on a life insurance policy or a 401(k) keeps the money out of probate, but it does not keep it out of the taxable estate.

What Actually Gets Taxed

The tax applies only to the portion of your estate above the basic exclusion amount. For 2026 that threshold is $15 million per individual.¹ The One, Big, Beautiful Bill Act, signed July 4, 2025, made the higher exemption permanent and replaced the temporary increase that had been set to expire at the end of 2025.² Amounts above the exemption are taxed on a graduated scale that reaches 40% on amounts more than $1 million past the threshold.³

For married couples, two provisions do most of the work. The unlimited marital deduction lets you leave any amount to your surviving spouse free of federal estate tax.⁴ Portability lets the surviving spouse inherit whatever exemption the first spouse didn’t use. Portability isn’t automatic. The executor has to file Form 706 to claim it, even when no tax is owed, and estates below the filing threshold get up to five years to file a simplified late-portability election if they miss the initial deadline.⁵

Why Life Insurance Counts Even With a Named Beneficiary

A $2 million policy paid directly to your daughter still counts as part of your taxable estate if you owned the policy when you died. The check going straight to her is irrelevant for estate tax purposes. What matters is whether you held any “incidents of ownership” at the time of death, and if you did, the full death benefit gets added to your gross estate.⁶

Incidents of ownership is broader than being listed as the owner. It covers any legal power over the policy’s economic value: the ability to change beneficiaries, cancel or surrender the policy, borrow against its cash value, or pledge it as collateral.⁷ Retain any one of those, and the entire death benefit is included at full face value, not at what you paid in premiums.

Employer Group-Term Coverage

Group life through your employer follows the same rules. The power to change the beneficiary is itself an incident of ownership, and so is the right to convert group coverage to an individual policy when you leave.⁶ You can irrevocably assign the policy to remove it from your estate, but only if both the plan document and your state’s law permit absolute assignment. The ability to end coverage by quitting your job does not count as an incident of ownership.

Getting a Policy Out of Your Estate

The two ways to keep a large policy out of your gross estate are to have someone else own it from day one, or to transfer ownership away from yourself. Transfers carry a hard deadline: if you give away a life insurance policy and die within three years, the IRS treats the proceeds as though you still owned it, and the full death benefit comes back into your taxable estate.⁸ This applies whether you gifted the policy or sold it for less than fair value, and it applies to assignments of employer group-term policies too. Waiting until a diagnosis defeats the strategy.

Irrevocable Life Insurance Trusts

The standard tool for keeping a policy out of your estate is an irrevocable life insurance trust. The trust owns the policy, the trust pays the premiums, and the trust collects the death benefit. Because you never held incidents of ownership, the proceeds stay outside your gross estate.

The details matter. You cannot serve as trustee if the trust gives the trustee any power a policy owner would normally have; the document should appoint a separate insurance trustee with sole authority over the policy, and it must prevent you from exercising any power for your own benefit.⁷ Transferring an existing policy into the trust starts the three-year clock. Having the trust buy a new policy from the outset avoids that entirely.

Premium funding needs its own treatment. Cash you contribute to the trust so it can pay premiums is a gift. To keep contributions within the annual gift tax exclusion, ILIT trustees typically give beneficiaries a temporary right to withdraw the contributed amount (Crummey powers), converting a future-interest gift into a present-interest gift that qualifies. The withdrawal window is usually 30 to 60 days, and the trustee should send written notice with each contribution.

Retirement Accounts: Included, No Matter Who the Beneficiary Is

The fair market value of your 401(k), traditional IRA, Roth IRA, 403(b), and similar accounts on the date of death is part of your gross estate.⁹ The beneficiary designation lets the funds skip probate, which is a different process from estate tax. For estate tax, the IRS looks at whether the decedent had the right to receive distributions during their lifetime, and every account owner does.

Roth IRAs catch people out. Because distributions are income-tax-free to the beneficiary, many owners assume the account is exempt from estate tax too. It isn’t. A $1.5 million Roth is added to the gross estate exactly like a traditional IRA of the same value.⁹

The Double-Tax Problem

Retirement accounts are one of the few assets that can get hit by both estate tax and income tax. Unlike stocks or real estate, an inherited retirement account does not receive a stepped-up basis. Your beneficiary owes ordinary income tax on every dollar withdrawn from an inherited traditional IRA, on top of any estate tax that already applied to the account’s value.

The tax code partially offsets this. A beneficiary who reports inherited retirement distributions as income can deduct the portion of federal estate tax attributable to those distributions. The math compares the estate tax actually paid against what it would have been with the retirement accounts excluded from the gross estate; the difference is the estate tax attributable to those assets, and the beneficiary deducts a proportional share as distributions come out.¹⁰ It’s an itemized deduction on the beneficiary’s income tax return, not something the estate claims. It doesn’t erase the overlap, but it takes real money off the combined bill.

The 10-Year Payout Rule

Since 2020, most non-spouse beneficiaries who inherit a retirement account must empty it by the end of the tenth year after the owner’s death.¹¹ The old “stretch” over the beneficiary’s lifetime is gone for most heirs. For a large inherited account, the compressed schedule can push a beneficiary into higher income tax brackets during those ten years, which compounds the double-tax problem for taxable estates.

A narrower group is exempt: surviving spouses, minor children of the account owner (until they reach the age of majority), disabled or chronically ill individuals, and beneficiaries not more than 10 years younger than the decedent. These “eligible designated beneficiaries” can still stretch distributions over life expectancy.¹¹

What the Executor Files

When the gross estate exceeds $15 million, the executor must file Form 706, the United States Estate (and Generation-Skipping Transfer) Tax Return. Every asset, including life insurance proceeds and retirement account balances, goes on the return at fair market value on the date of death.¹² If choosing an alternate valuation date six months after death would reduce both the gross estate and the tax owed, the executor can elect that instead.¹³

Form 706 is due nine months after the date of death. Form 4768 buys an automatic six-month filing extension, but the tax owed is still due at the nine-month mark. Unpaid balances accrue interest and penalties from that date.¹² Estates below the filing threshold still have a reason to file: preserving the surviving spouse’s ability to use the deceased spouse’s unused exemption through portability.

1
Internal Revenue Service. What’s New — Estate and Gift Tax
2
Office of the Law Revision Counsel. 26 USC 2010 – Unified Credit Against Estate Tax
3
Office of the Law Revision Counsel. 26 USC 2001 – Imposition and Rate of Tax
4
Office of the Law Revision Counsel. 26 USC 2056 – Bequests, Etc., to Surviving Spouse
5
Internal Revenue Service. Revenue Procedure 2022-32
6
Office of the Law Revision Counsel. 26 USC 2042 – Proceeds of Life Insurance
7
Internal Revenue Service. Private Letter Ruling 201919003
8
Office of the Law Revision Counsel. 26 USC 2035 – Adjustments for Certain Gifts Made Within 3 Years of Decedent’s Death
9
Office of the Law Revision Counsel. 26 USC 2039 – Annuities
10
Office of the Law Revision Counsel. 26 USC 691 – Recipients of Income in Respect of Decedents
11
Internal Revenue Service. Retirement Topics – Beneficiary
12
Internal Revenue Service. Instructions for Form 706
13
Office of the Law Revision Counsel. 26 USC 2032 – Alternate Valuation