Generally speaking, a life insurance policy is not going to count when considering the assets a person owns and determining what they owe for estate taxes. This is because, although the policy was purchased by that individual, the funds from the payout are not actually part of their estate.
In fact, many people use life insurance policies to get around estate tax issues or to address them upfront.
For example, someone with a relatively high-value estate may know that their family is going to have to pay estate taxes upon their passing. They take out a life insurance policy with a specific payout that is close to what they believe will be due in taxes. The goal of this policy is to pay the taxes without actually depleting their estate, meaning that the assets they own are passed on to their family and not the government.
There are some exceptions
You can find exceptions to this rule. Notably, if the life insurance policy does pay out into the person’s estate directly, then it will be counted with their other assets when determining what is due in estate taxes.
This usually happens if the person has not selected a beneficiary. When there is a beneficiary, the life insurance policy skips over probate, and the insurance company directly pays that beneficiary, so there is no issue. But the money is still due even if a beneficiary has not been selected, and so the payout could be transferred directly to that person’s estate. It is then counted for tax purposes, along with the other assets that they owned at the time of their passing.
In other words, it is very important to carefully plan ahead to avoid estate tax issues, and it can help to know exactly what legal steps to take.