Using Life Insurance for Estate Planning
While you may not want to think about what life will be like when you are gone, the reality is that it is important to be prepared for certain situations – regardless of whether you’re young or old. Accidents, illnesses, and other events can and do occur. And in order for you and those you care about to have ongoing financial security, an effective estate plan is oftentimes necessary.
This can be the case even if your family doesn’t have a substantial amount of wealth, as you will still want to ensure that your assets will be passed on the way that you want them to be. You will also want to be sure that the people you care about most will not have to endure ongoing financial hardship in the future.
Why Have an Estate Plan?
Many people may believe that it is necessary to be wealthy in order to require an estate plan. This, however, isn’t necessarily the case. While estate planning can – and often is – used for reducing or eliminating the high cost of estate taxes, there are also many other reasons to engage in this type of planning, regardless of the amount of assets that you have.
In fact, without a proper estate plan in place, you run the risk of leaving your assets, and your loved ones, open to the expensive, time-consuming, and public process of probate. Regardless of whether or not you have a will, it is possible that your estate could still be required to go through the probate process.
During probate, the debts of your estate are paid off using your assets, and then the remaining assets – if any – are distributed to the beneficiaries. If you have a valid will, the assets may go to the named individuals. If not, individuals will be determined by the estate’s executor – and they may not always be your first choice.
There are expenses that go along with probate, too, such as legal and court costs – which in turn can leave less for your heirs to inherit. In some cases, the cost of probate can be as much as 15% of your total estate. Probate is also public. This means that it is a matter of public record and all of the assets and liabilities of your probated estate may be available for the public to see.
Because of all these negatives, many people will do all that they can in order to avoid probate. One of the best ways to do so is to have an estate plan. But in addition to just avoiding probate, there can be other dangers in not having an estate plan in place, too.
For instance, in some cases, there may be disagreements among family members, business partners, or other individuals regarding “who is entitled to what” when you pass on. This, and other questions, can be quickly and easily answered in an estate plan.
Estate planning can also help you to equalize an inheritance among your heirs. As an example, if a business owner has two children, and only one of those heirs is interested in taking over the company, other steps can be taken in order to provide for the other child. One way of doing so is through life insurance and setting up the allocation of your beneficiaries on a life insurance policy.
Life Insurance and Estate Planning
Life insurance can help you to accomplish your estate planning objectives in a number of different ways. This important financial tool can be extremely versatile, which is why it is often used in these types of plans.
Some of the more common life insurance estate planning strategies include the following:
First and foremost, life insurance has the ability to essentially “create” an immediate estate. And, it can oftentimes do this for pennies on the dollar. What this means is that in exchange for just paying the policy’s premium, a life insurance policy will pay out a large sum to your beneficiaries.
The funds that are received from a life insurance policy are income tax-free. These funds will also bypass probate and go directly to the designated individual (or individuals) that they are intended for.
Payment of Estate Taxes
Depending on the total amount of your estate, your heirs may owe federal (and in some cases, state) estate taxes. These can come out to be a substantial portion of your gross estate, and they must be paid within nine months of your passing.
Life insurance is often used for paying estate taxes that are due. This is because in exchange for the payment of the life insurance policy’s premium, your estate can easily come up with the amount of tax payment that is due.
When using life insurance for estate tax planning, though, it is important to be sure that the life insurance policy is not included in the overall estate itself as an asset. This means removing the calculation of the proceeds from the estate. Otherwise, your estate could end up owing even more.
One of the best ways to ensure that life insurance proceeds are removed from your estate is to create an irrevocable life insurance trust, or ILIT. In order to complete the transfer of ownership, the insured cannot be the trustee of this trust, nor can he or she retain any rights to revoke the trust.
Life insurance can also be used for the preservation of assets. For example, rather than having to sell off investments or assets – often at below market value – in order to pay the estate taxes that are due and / or to pay final expenses, the proceeds from a life insurance policy can instead be used. These proceeds provide a relatively low-cost source of funding that can be received income-tax free to the recipient(s).
Proceeds from a life insurance policy can also be used for funding the buy-out of a closely held business interest of a decedent. These funds can help to provide the liquidity that is needed to move the transition forward.
For example, the proceeds from a business owner or partner’s life insurance policy can essentially create a sum of money at his or her death that can be used for keeping the company afloat while a replacement is being sought, or while the company is being prepared to be sold.
These proceeds can also be used to pay the business owner’s family the full value of his or her ownership interest. This means that if a spouse and / or other survivors were dependent on income from the business, the insurance proceeds can help to replace this income.
Best Type of Life Insurance for Estate Planning
Life insurance in estate planning is actually very common. This is because life insurance can serve a number of important purposes, including as a source of support, expense coverage, and liquidity for paying taxes and other needs.
When using life insurance for estate planning purposes, you will need to be sure that the right type of coverage is put in force. For example, using term life insurance for estate planning is often not as solid of a strategy as using a permanent type of life insurance policy. This is because term life insurance policies are purchased for only a certain length of time, such as 10 years, 20 years, or 30 years.
Once a term life insurance policy has expired, it is often necessary for the insured to re-qualify for coverage at his or her then-current age and health status if they wish to continue being covered. Because they are older at that time, the new policy’s premium will typically be much higher.
If, however, the insured has contracted an adverse health condition, they may not even be insurable as now they may have health conditions that make them high risk to a life insurance company. This can be risky in that life insurance may no longer be available to them. Because of that, term life insurance is generally not the best option for estate planning purposes.
Rather, a permanent form of coverage makes much more sense. Using whole life insurance for estate planning, for instance, will provide you with coverage that will last throughout the remainder of the insured’s lifetime, regardless of his or her increasing age, and whether they contract an adverse health condition – provided that the premium continues to be paid.
In addition, with a whole life insurance policy, the policy holder can also obtain additional benefits such as the tax-deferred build-up of cash value in a life insurance policy. Because of the tax-advantaged growth of the cash value component, the funds in the cash account can grow significantly over time.
Another form of permanent coverage, universal life insurance for estate planning, may also be beneficial. This type of policy also provides both death benefit coverage and a cash value component.
However, universal life insurance is often considered to be more flexible than whole life insurance. This is because with universal life insurance, the policy holder can typically choose, within certain limitations, how much of the premium dollars will go into the death benefit, and how much will go into the cash value component of the policy. They may also be able to change the due date of the premium based upon their changing needs.
One of the most inexpensive ways to obtain a permanent death benefit is to go with a Guaranteed Universal Life, or GUL, policy. These types of policies essentially combine some of the best features of term and permanent coverage.
For example, you can get level premiums for life, along with a guaranteed death benefit up to a certain age – through 121, depending on the carrier. And, while the cash surrender value in these policies will generally remain somewhat low, the premium is also quite low as compared to other types of permanent life insurance coverage. So, unless you’re using the policy as a savings vehicle – which you likely won’t be in the case of estate planning – a GUL could provide a nice policy alternative.
Determining the Best Life Insurance Policy for Your Needs
Once you have decided on the best life insurance for estate planning in your specific situation, then the next step should be to determine the proper amount of coverage to purchase. This is because you will want to ensure that you have enough proceeds for all of your estate planning needs.
These may include any number of requirements, such as providing an inheritance to loved ones, paying off specific debts, the payment of final expenses, and / or ensuring an ongoing income for a surviving spouse.
Once you have determined the proper type and amount of life insurance coverage for your estate planning requirements, it will be important to compare policies from several different carriers (which we do better than anyone else for our clients). This is because the premium costs can vary on life insurance coverage – even on policies that provide the same amount of benefit.
With that in mind, working with an independent life insurance agency that has access to multiple insurance carriers is typically the best way to get an unbiased policy comparison. This can allow you to choose the policy, the benefits, and the premium quote that works the best for you and your specific situation.
Considerations When Planning Your Estate
When planning your estate, there are several factors that you will need to consider. First, you will want to be sure that the proceeds of the life insurance policy are not included in the insured’s estate and that he or she has an incident of ownership in the policy. (An incident of ownership will typically include the right to assign, terminate, name a beneficiary, change a beneficiary, and / or to borrow against the policy’s cash value). Otherwise, the amount of the life insurance policy’s proceeds could be subject to inclusion in the insured’s estate – and thus to estate taxation.
Therefore, in order to help in avoiding this, it will be important to set up a life insurance trust for estate planning. This is because even just naming the estate as the beneficiary will not remove the policy’s death benefits entirely from being includable in the decedent’s gross estate.
However, by making the beneficiary of the life insurance policy an irrevocable trust, assets can instead be protected. In doing so, it is typically best to consult with an experienced advisor to determine your life insurance requirements, as well as in setting up the trust.
Also, once your estate plan has been created, it is not a “set it and forget it” type of plan. Just as life is constantly changing, it will be important to regularly review your plan and to update it whenever changes are needed.
Ideally, you should review your estate plan at least every year. However, you should do so more often if you have had any type of major life changing event. These events would include a birth or death in the family, marriage or divorce, retirement, purchase or sale of a business, or other key occasion.
Taking the Next Step
While estate taxes may never be entirely eliminated, there are ways in which you can reduce them. You can also protect your loved ones and ensure that your assets are shielded from the probate process by creating a solid estate plan.
One of the best ways to ensure that you will have the liquidity that you need, for pennies on the dollar, is by having life insurance included in estate planning. Knowing how to use life insurance for estate planning can provide liquidity and control. No other financial tool can offer the benefits that life insurance does.
If you are ready to take the next step towards setting up an estate plan using life insurance, we can help. We work with more than 40 insurance carriers, and we can work with you in determining the best plan for you.
We can provide you with instant quotes in just minutes – directly from our website. We have helped thousands of families to get the life insurance coverage that they need – and we will be happy to work with you.
So, whether you are in the initial stages of your estate planning process, or you are reviewing a plan that needs to be updated, contact us at 855-924-5433 and we’ll provide you with a policy that is right for you.