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Life Insurance for Estate Planning [5 Fantastic Benefits]
Your estate is all the property you own. Your estate may be large or it may be small. Life insurance can make a small estate large, or it can be used to protect a large estate. When considering life insurance for your estate plan it is important that you have choices and understand the benefits of each type of coverage and how each plays into your estate planning goals.
Many people have at least a small life insurance policy through work or for burial and final expenses. However, the majority of individuals fail to maximize their estate through the use of life insurance. In our opinion, life insurance and estate planning should be synonymous.
When it comes to using life insurance for estate planning, there are various strategies available using cash value life insurance that can be used to increase the value of your estate and avoid taxes. The following article covers the value of life insurance in an estate plan, ways to use life insurance to avoid estate taxes and explains the different types of life insurance available.
Including life insurance in your estate plan
Who or what you choose as your life insurance beneficiary can have a huge impact on how your estate is taxed or on the fees your estate must pay upon your death. The easiest way to include life insurance in your estate plan is to name your spouse as the primary beneficiary and the trustee of your Family Trust as the contingent beneficiary of the life insurance proceeds.
Another more in-depth way to include life insurance in your estate plan is via an Irrevocable Life Insurance Trust (ILIT). You may want to consider an ILIT if the total assets in your estate will exceed the current exemption amount.
Estate planning if you are single with no dependents
If you are single, and have no dependents and no debt, then you probably do not need life insurance, although you should consider the benefits of permanent cash value life insurance. Although you might want to consider life insurance to protect you future insurability since nothing in life (such as health) is guaranteed. In this way, if you do plan on getting married and having kids someday, you already locked into life insurance. Further, if you develop a condition that would prevent you from qualifying for life insurance down the road you will already have a policy in place.
If you do plan on buying life insurance to protect future insurability, term life insurance with an option to convert to a permanent policy may be your best choice. A $500,000 ten year term for a healthy 29 year old male runs about $165 a year. If life throws a curve ball at you in the next 10 years and you can no longer qualify for life insurance you can always convert your policy to a permanent policy. The flip side is you do not have life insurance, develop some disease that precludes you from getting life insurance and you are out of luck. Is it worth the gamble for $165 a year?
Estate planning as the primary bread winner
If you are the primary bread winner of the household then you may need life insurance to replace your income. This is imperative for the main income earner who has a large mortgage or debt. If you have been able to put money aside and you have a lot of readily available cash than your need for life insurance will be less. However, even someone with a lot of cash on hand might want to consider getting a few years worth of income replacement to protect against the unexpected and provide liquidity for his or her estate. The primary bread winner of the household should consider getting about 7-10 years worth of income, especially if there are young children at home.
You can check out our life insurance rates by age chart to see why locking into coverage today can save you and your estate a ton of money.
Estate planning with young kids or kids with special needs
If you have young children or if you have a child with special needs, then life insurance is very important. A parent with young kids may want to consider a term life insurance policy that protects the kids until the youngest is at least age 18. Parents of special needs children will want to consider a longer term, such as a 30 year term, or even a whole life or universal life insurance policy to protect the child with special needs. Setting up a special needs trust would also be prudent.
Business owner estate planning with life insurance
A business owner would want to consider a buy-sell agreement funded with life insurance. A buy-sell is structured so the surviving partner has money to buy out the heirs of the deceased partner's share in the business. This protects against having an unqualified heir of your business partner step in or having to close the business due to lack of funds available. This is an awesome life insurance strategy for business owners but all too often business owners wait too long to move on this option. As a result, age and pre-existing conditions make it very difficult to afford life insurance. The moral of the story, don't wait to get life insurance in your old age. Get life insurance while you are young and healthy.
For the sole proprietor, partner, or business owner of a C Corp, LLC or S Corp, key man life insurance is another great vehicle for safeguarding your business for your family if you die unexpectedly.
Estate planning using life insurance for high net worth clients
High net worth individuals need to understand how insurance and estates work together. A high net worth individual could use life insurance to help provide liquidity for their estate and pay any estate tax that may be due. The current federal exemption for estate tax is not set in stone and a lower exemption down the road will force a lot of estates to make changes (such as purchasing life insurance) to offset their losses due to estate taxes. A prudent step to take would be to set up an irrevocable life insurance trust for estate planning in advance if you are close to exceeding the exemption limit. You may even consider funding the ILIT with a single premium life insurance policy.
Estate planning for the non citizen spouse
If you are designing an estate plan using life insurance and your non citizen spouse is the beneficiary of your policy then you should check out our article covering life insurance and non U.S. residents.
Types of life insurance for estate planning
There are various types of life insurance policies. Below we list the two common types of life insurance for estate planning: whole life insurance versus term life insurance.
Term: Term life insurance is designed so that the life of the primary insured is protected for a set period of time. Term life insurance offers 10 year terms up to 30 year terms. Most policies are guaranteed renewable to age 90, with some companies offering policies to age 95 and most term policies have a built in conversion option, which typically needs to be exercised by the end of the term or age 70, whichever comes first.
You can also choose return of premium term life insurance. This is a great tool because all your premiums are returned at the end of the policy so you either get all your premiums back or your beneficiary receives the death benefit of your policy.
Whole Life: Whole life insurance lasts for the primary insured’s “whole” life. As long as the premiums are paid the life insurance policy will continue until the day the primary insured dies. Whole life policies build cash value that can be borrowed against. Whole life is a great option for an estate plan as the cash value can be accessed tax free via policy loans for various reasons, such as
- Retirement Income
- Long Term Care
- Business Succession
The key to using this type of policy is to choose from among the best whole life insurance companies in the marketplace.
Guaranteed Universal Life (GUL): A guaranteed universal life policy offers a whole life policy that builds some cash value with the lower fixed premium of a term life insurance policy. A GUL policy works well for estate planning with life insurance because, unlike whole life or variable universal life, the premiums are more manageable. However, trade off with lower premiums is lower cash value, which has many benefits for estate planning.
Second to die life insurance: A second to die universal life insurance policy is a great estate planning tool. Also known as a survivorship life insurance policy, it is typically cheaper than a whole life or universal life policy on an individual, paying out the face amount of the policy upon the death of the second spouse. A second to die policy is ideal for a couple wanting to leave a larger estate to their children, a charity, or some other worthy cause.
Indexed Universal Life (IUL): An IUL is another great tool for estate planning. You can read more on IUL's in the following article: Indexed Universal Life Insurance Pros and Cons.
How much life insurance do I need for my estate plan?
There is no one size fits all answer. How much life insurance someone needs will be vastly different from one person to another. Some factors to consider are:
- Do you own a business? How much cash would be needed to buy out your business partner?
- Will you owe estate taxes? How much life insurance is needed to pay off estate taxes?
- Do you have a mortgage? How much cash is required to pay off your mortgage?
- Do you have young children? How much cash would be needed to provide for their schooling, now and throughout their life?
- Are you the primary bread winner? How much cash would be needed to replace your income so that your wife and/or kids will be taken care of for 5-10 years?
Other factors that will influence the right answer to this question for you is how much liquidity you have. Do you have cash on hand or will your family be required to dip into a 401K, stock or mutual fund portfolio, or sell real property? How you answer all these question will give you a good idea of how much life insurance for estate planning you need. For more on this topic and other FAQ, please see our life insurance 101 section under how much life insurance do I need.
Life insurance for large estates
We cannot beat the drum enough for including life insurance in an estate plan. An irrevocable life insurance trust is ideal for someone with a large estate who will be forced to pay estate taxes because their estate exceeds the current federal estate tax exemption of $5,430,000 in 2015. Using an irrevocable life insurance trust, the funds from the trust can be used to pay the estate tax.
Another benefit of an irrevocable life insurance trust is that it creates liquidity so that funds are available right away. Often, administering and settling a trust can take many months and going through probate can take years in some cases. Having cash readily available will help the estate avoid having to liquidate any assets, such as real property, in order to raise money to pay any taxes or bills due upon the passing of the decedent.
5 advantages of life Insurance in an estate plan
If you are looking to grow your estate or protect your current estate, life insurance can be a great tool. There are five big advantages to incorporating life insurance in your estate plan.
1. It creates an immediate estate
One of the most important advantages of including life insurance in an estate plan is that it creates an immediate estate. You do not have to wait for a trust to settle or for probate to close.
The funds from the policy are available right away (typically all that the life insurance company requires is the death certificate). The proceeds are then used to protect your current estate by providing immediate cash, paying for administration and settlement of a trust or probate, burial, and taxes.
2. Helps avoid taxes
Another huge benefit of life insurance for estate planning is that it typically will not be subject to an estate tax or a death tax.
One way to avoid paying taxes for those with a state death tax or with an estate valued over the federal exemption limit is to fund an Irrevocable Life Insurance Trust (ILIT). The advantage of life insurance purchased through an Irrevocable Life Insurance Trust is that the death benefit typicaly won't be subject to estate tax.
3. Maximizes your total worth: i.e. leverage
Using life insurance for estate planning allows you to leverage your assets to maximize you total worth. For example, a 50 year old male in perfect health can get a $500,000 Guaranteed Universal Life (GUL) insurance policy for a little over $4,000 a year. If he died at 82, the normal life expectancy of a healthy 50 year old, he would have paid 32 years worth of payments, or around $128,000 in total premiums. His beneficiaries will receive $500,000. A net gain of $372,000 for his estate, or four to one (4-1) on his money. Worst case scenario is he lives to 121 (fat chance). At that point the policy is worth the face amount of $500,000. He paid 70 years of premium, or $280,000 and still received close to 2-1 on his money.
4. Tax free source of retirement income
Using life insurance for estate planning can also provide for protection in retirement. Although it appears to be popular nowadays to bash permanent life insurance, permanent life insurance can add a significant resource in retirement. The cash value in the policy can be borrowed against and used for tax free retirement income.
5. Protection against disability or long term care
You can add certain life insurance riders to your policy to gain protection for a disability, long term care, and critical illness. However, simply having permanent life insurance with cash value can provide a great source of liquidity to be used if you become disabled. Taking out tax free policy loans to cover you if you need long term care can go far in preserving your estate for your beneficiaries.
Revisit your estate plan
You should revisit your estate plan, including your life insurance policy, whenever a major life event occurs, such as the birth of a child, death of a beneficiary, or a divorce. You should also review the terms of your trust if you have moved from one state to another. Estate planning rules vary from state to state so it is prudent to have an attorney look over your estate planning documents if you moved from the state you originally had your documents prepared.
If you require help from a professional to evaluate your specific life insurance need or if you would simply life a free consultation to see if you have the right amount of life insurance for your estate plan or the right policy in place for your estate plan, please give TermLife2Go a call today.
This information is designed to provide a general overview with regard to the subject matter covered and is not state specific. The authors, publisher and host are not providing legal, accounting, or specific advice to your situation.