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Life Insurance Strategies for Estate Planning

Fact Checked by Jason Herring & Barry Brooksby
Licensed Agents & Life Insurance Experts.
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Life Insurance for Estate Planning

When most people think about estate planning, they think about setting up legal documents like wills, trusts and durable powers of attorney. However, there is another important part of the estate planning process that concerns the role of life insurance for estate planning which uses the right life insurance coverage to accomplish specifically identified estate planning goals.

In this article we will discuss life insurance for estate planning, by going over a simple summary of the estate planning process, followed by the various ways life insurance is used in this process AND, finally, wrapping up with some recommendations for the major types of life insurance policies that are suited for various estate planning goals.

Benefits of Life Insurance in Estate Planning

One of the most significant benefits of life insurance as part of a comprehensive estate plan is that the insurance provides both liquidity and leverage.

Liquidity and Leverage

Having available cash on hand upon the death of a spouse, business partner or parent is so valuable it cannot be understated how much this benefit can protect an estate. Through the cash from a life insurance payout, the beneficiary has immediate liquid cash that can be used to pay off creditors and other debts or expenses that may arise.

Trust administration can take 3-6 months to finalize and probate can take a year or more. A death benefit payout from life insurance provides a fast way to increase an estate’s liquidity when it is needed most.

In addition to liquidity, life insurance provides leverage. Particularly when we are focused on a death benefit, rather than cash value accumulation, a relatively small sum of money can purchase a large death benefit. The leverage created can increase an estate substantially.

Estate Protection from Disability or Long Term Care

Most life insurance policies have provisions that allow a portion of the death benefit to be used if the insured cannot perform 2 of 6 activities of daily living. Rather than the estate having to come up with large amounts of money to pay for a convalescent home or nursing care, the life insurance death benefit can be accessed in advance.

In addition, specific riders can be added providing long-term care life insurance benefits. Long term care riders and chronic illness riders attached to your life insurance can be a huge blessing to your estate as an alternative to using estate assets to pay for long term care.

Introduction to Estate Planning with Life Insurance

Estate planning is the process of taking an inventory of your estate assets AND creating an estate distribution plan for those assets upon your death.

Creating an estate distribution plan is about determining who will get what portion of your assets. This is accomplished by preparing legal documents that describe who will be in charge of the estate upon your death and will will receive the assets. Key estate planning documents generally include:

  1. Last Will and Testament
  2. Revocable and Irrevocable Trusts
  3. Durable Powers of Attorney
  4. Advance Medical Directives
  5. Guardianship or Conservatorship

Estate planning documents are state specific AND must be executed in accordance with specific legal formalities. Thus it is advisable to avoid shortcuts such as do it yourself (DIY) estate planning for most estates.

In short, estate planning documents must be carefully drafted and signed according to state laws in order to be deemed enforceable.

Estate assets are defined as anything that you own that has value. Examples of estate assets may include but may not be limited to:

  1. Real Estate
  2. Vehicles
  3. Qualified Financial Accounts (401(k) and 403(b) accounts)
  4. IRAS and Life Insurance Products
  5. Stocks and Bonds
  6. Personal Property (guns, stamps, knives, coins, antiques, jewelry)
  7. Business Entities
  8. Patents and Trademarks
  9. Digital Assets

Specific estate planning objectives in addition to preparing a distribution plan for estate assets, may include some additional planning to accommodate issues such as:

  1. Estate Taxes
  2. Business Continuity Succession
  3. Family Business Succession
  4. Charitable Planning
  5. Special Needs or Pre-Medicaid
  6. Generational Planning
  7. Spousal Planning
  8. Funeral Expenses and Burial Costs

Federal estate taxes are a major focus of estate planning for wealthier families. The federal estate tax has also been named by detractors as a “death tax” which is a purported reason why it was created, to prevent family dynasties from perpetuating as in feudal times.

However, this tax has had a bit of a nasty backlash for asset heavy businesses that are forced to liquidate to pay the tax. Federal estate tax is approximately 40% of your taxable estate and is generally required to be paid within 9 months of the estate owner’s date of death. Businesses such as sports teams or car dealerships have not fared well under this tax.

The good news if you’re facing the federal estate tax, is the amount that is exempted from this tax recently increased substantially, due to the Tax Cuts and Jobs Act of 2017, and is now $11,200,000 for individuals and $22,400,000 for a married couple.

Business continuity succession planning is the estate planning process for maintaining the continuity of a business following the death of major shareholders or contributors. Usually a death will rock the foundations of the business, thereby necessitating a buyout of some kind in the form of a buy-sell agreement to be discussed shortly. Without a plan, catastrophes often strike in this area of estate planning.

Family business succession is a subset of the above as it pertains to more intimate family businesses and may increase the likelihood of a sale to a third party.

Charitable planning is an estate planning priority that requires some careful planning and also offers tax advantages when done correctly. Charitable lead trusts (“CLT”) and charitable remainder trusts (“CRT”) are often used to obtain significant tax benefits in estate planning.

Special needs or pre-Medicaid estate planning is a complex area of estate planning because beneficiaries may be disqualified from public benefits due to improper planning around an estate distribution.

Generational or “dynasty” planning is about reserving a nest egg for future generations and this is often accomplished through the use of an irrevocable life insurance trust (ILIT).

Spousal planning of course is a common estate planning priority and can be especially challenging where second marriages are involved, particularly, where there are children from prior marriages.

When Using Life Insurance for Estate Planning Makes Sense

In general, life insurance for estate planning is used for a few purposes which may include any of the following:

  1. Providing a death benefit to beneficiaries
  2. Providing liquidity to assist the estate
  3. Providing spousal income and support

If federal estate tax planning is an issue, life insurance can be used to supply liquidity to pay the estate taxes. Again, this would be for an estate that is in excess of the exemption limits discussed above.

The good news is life insurance is not taxable when paid to a beneficiary, if your estate is below the Federal Estate Tax Exemption amount. That means your beneficiary will not have to pay income taxes on the death benefit payout.

If business continuity succession planning is required, then liquidity is also the objective, even if the estate tax is NOT an issue, because the life insurance proceeds may be used to finance the purchase of the business from the estate by a beneficiary OR a third party. Usually, business succession planning with a buy sell agreement that is funded by life insurance is the most effective way to do this kind of planning.

If family business succession planning is involved, the terms of the transition should be spelled out in the estate documents including any revocable or irrevocable trusts.

Also, a second-to-die life insurance policy may be beneficial where both spouses are active in the business and the surviving spouse will not need the death benefit.

Charitable estate planning may accomplished by assigning the death benefit or making a charity the contingent beneficiary of a life insurance policy.

Generational estate planning is often used to take care of future generations such as children and grandchildren. Often an irrevocable life insurance trust (ILIT) can be used for this purpose, although you must be careful to avoid incidents of ownership, which may turn off those who want control of all aspects of their estate. If a surviving spouse doesn’t need the death benefit, a second to die life insurance policy can fund the ILIT.

Special needs or pre-Medicaid estate planning may be accomplished by making an irrevocable special needs trust the beneficiary of a life insurance policy, thereby providing necessary support to a dependent beneficiary without disqualifying them from public benefits.

Finally spousal estate planning may be required where it is determined that a spousal will need additional income or support in order to maintain his or her current standard of living following the death of the income earner spouse. Life insurance proceeds are often utilized for the purpose of providing this additional support.

Types of Life Insurance for Estate Planning

The type of life insurance for estate planning will vary based upon the NOT ONLY the death benefit goals of the estate owner but also the lifetime goals AND the budget involved. ALL types of life insurance can be used for estate planning because the death benefit is what is important. However, as we age, life insurance gets more expensive and so the cheapest life insurance at the time may NOT be the best choice.

You may also be interested in our picks for the top 20 best permanent life insurance companies. Some are focused more on the initial death benefit, while other life insurance policies focus on the cash value growth, which may create a larger death benefit when all is said and done.

An overview of the major types of life insurance:
  1. Dividend Paying Whole Life Insurance
  2. Indexed Universal Life Insurance
  3. Variable Universal Life Insurance
  4. Guaranteed Universal Life Insurance
  5. Convertible Term Life Insurance

Dividend paying whole life insurance is the most expensive type of life insurance if you’re focusing strictly on the death benefit. So the thing to consider for estate planning is whether the cost justifies the permanence and stability of whole life policy because it is arguably the most stable of the 5 types. Whole life insurance builds cash value and earns life insurance dividends and thus offers benefits that extend beyond the scope of estate planning.

Indexed universal life insurance allows the life insurance policy holder to build cash value based upon market returns and offers more flexibility than whole life insurance. However, these policies are also arguably less stable due to market factors and the potential for under funding the policy. Thus, this type may NOT be as ideal for many estate planning goals.

Variable universal life insurance is even less stable that their IUL counterpart above, so these may also not be ideal where the death benefit is the primary goal.

Guaranteed universal life insurance is a solid option for estate planning life insurance because it provides a permanent death benefit at a relatively low cost. This type is also very stable and inexpensive when compared with the other types. However, this type of policy offers less life time benefits because either no cash value accrual or very limited cash value growth will accrue.

Convertible term life insurance is ideal for securing an inexpensive death benefit for estate planning purposes. However, all term policies expire and this makes having a convertible policy highly recommended so that a future permanent policy may be obtained if factors such as health or age lead to insurability problems.

How to Choose the Right Life Insurance Company and Policy

The best life insurance for estate planning will vary based on your needs, goals and objectives. Many people opt for a guaranteed universal life insurance policy because of the low premiums and high death benefit. And if the primary purpose is to benefit the estate, second-to-die insurance is often chosen.

However, often the better route to take if you believe you still have many years of life left is to choose a cash value policy, such as dividend paying whole life, where the death benefit grows over time. Although the initial death benefit is lower than with the guaranteed universal life policy, overtime the death benefit of a properly structured whole life policy may far surpass what other insurance policies will offer.

The good news is we are here to help you make the best decision for your estate. Give us a call today for a free consultation.




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