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 policy to accomplish specific goals of a comprehensive estate plan.
Benefits of Life Insurance for Estate Planning
Income Tax Free Death Benefit
One great benefit of life insurance for estate planning is that life insurance is not taxable when paid to a beneficiary, if your estate is below the Federal Estate Tax Exemption amount, which means your beneficiary will not have to pay income taxes on the life insurance payout.
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. Through the cash from a life insurance payout, the beneficiary has immediate liquidity 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 life insurance death benefit payout provides a fast way to increase an estate’s liquidity when it is needed most.
A life insurance policy also 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.
Estate Planning with Life Insurance
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 an estate plan because the death benefit is what is important. However, as we age, life insurance gets more expensive and so the cheapest life insurance while you are young may NOT be the best choice.
Types of Life Insurance for Estate Planning
There are two primary types of life insurance, term life and permanent life insurance. And within the category of permanent life insurance there is whole life and universal life.
- Dividend Paying Whole Life Insurance
- Indexed Universal Life Insurance
- Variable Universal Life Insurance
- Guaranteed Universal Life Insurance
- Convertible Term Life Insurance
Dividend Paying Whole Life Insurance
Dividend paying whole life insurance is the most expensive type of life insurance policy if you’re focusing strictly on the death benefit. So the thing to consider for an estate plan 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
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
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
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. GULs are also very stable and inexpensive when compared with the other types of coverage. However, a GUL policy offers less life time benefits because either no cash value accrual or very limited cash value growth will accrue.
Term Life
Convertible term life insurance is ideal for securing an inexpensive death benefit for an estate plan. 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.
| Click the ⋆ for more info | Term Life | Guaranteed Universal Life | Indexed Universal Life | Variable Universal Life | Whole Life |
|---|---|---|---|---|---|
| Death Benefit | ⋆ | ⋆ | ⋆ | ⋆ | ⋆ |
| Tax Advantages | ⋆ | ⋆ | ⋆ | ||
| Market Opportunity | ⋆ | ⋆ | |||
| Cash Value Guaranteed | ⋆ | ||||
| Flexible Premiums | ⋆ | ⋆ | |||
| Low Premiums | ⋆ | ⋆ | |||
| Fixed Costs | ⋆ | ⋆ | ⋆ | ||
| Chronic Care Benefits | ⋆ | ⋆ | ⋆ | ||
| Convertability | ⋆ | ||||
| No Exam | ⋆ | ⋆ | ⋆ | ⋆ | ⋆ |
| Second to Die Option | ⋆ | ⋆ | ⋆ | ⋆ | ⋆ |
When to Use Life Insurance for Estate Planning
In general, life insurance for estate planning is used for a few purposes which may include any of the following:
- Providing Liquidity for Estate Taxes
- Providing a death benefit to beneficiaries
- Providing liquidity to assist the estate
- Providing spousal income and support
Federal Estate Taxes
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 why it was created, to prevent family dynasties from perpetuating as in feudal times.
However, the death tax has had a bit of a nasty backlash for asset heavy businesses that are forced to liquidate to pay the tax. If you have to pay estate taxes, they are approximately 40% of your taxable estate and are 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 and is now $13,610,000 for individuals and $27,220,000 for a married couple
If federal estate tax planning is an issue, a life insurance policy can be used to supply liquidity to pay estate taxes. Again, this would be for an estate that is in excess of the exemption limits discussed above.
Business Continuity Succession Planning
Business continuity succession planning is about 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.
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.
Charitable Planning
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. Some ways charitable estate planning is accomplished is by assigning the death benefit or making a charity the contingent beneficiary of a life insurance policy.
Special Needs Planning
The purpose of life insurance for special needs is to replace the income of the deceased caregiver and provide a nest egg to support the loved one for years to come.
Special needs planning is a complex area of estate planning because beneficiaries may be disqualified from public benefits due to improper planning around an estate distribution.
Special needs 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.
Dynasty Planning
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).
Also, a survivorship life insurance policy, a/k/a as second to die insurance, is beneficial where both spouses are active in the business and the surviving spouse will not need the death benefit or you desire to leave a legacy to your heirs.
Often high net worth families will use an irrevocable life insurance trust. How it works is an Irrevocable Life Insurance Trust (ILIT) is set up by a grantor to own a life insurance policy instead of an individual owning it directly. The main goal of this arrangement is to exclude the life insurance payout from the grantor’s personal estate. This exclusion reduces the estate’s total taxable value and, consequently, decreases potential estate taxes upon the grantor’s death.
Though there are various methods to pay the premiums for the life insurance within an ILIT, one common approach uses the grantor’s annual gift tax exclusion, which was $18,000 in 2024. This tactic not only finances the insurance but also helps in lowering the grantor’s taxable estate by moving money out of it.
Spousal Planning
Finally spousal estate planning may be required where it is determined that a spouse will need additional income or support 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.
Spousal planning is a common estate planning priority and can be especially challenging where second marriages are involved, particularly, where there are children from prior marriages.
Estate Planning Basics
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, which is accomplished by preparing legal documents that describe who will be the trustee of your estate upon your death and will will receive the assets.
Key estate planning documents generally include:
- Last Will and Testament
- Revocable and Irrevocable Trusts
- Durable Powers of Attorney
- Advance Medical Directives
- 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. Estate planning documents must be carefully drafted and signed according to state laws in order to be deemed enforceable.
What are Estate Assets?
Estate assets are defined as anything that you own that has value. Examples of estate assets may include but may not be limited to:
- Real Estate
- Vehicles
- Qualified Financial Accounts (401(k) and 403(b) accounts)
- IRAS and Life Insurance Products
- Stocks and Bonds
- Personal Property (guns, stamps, knives, coins, antiques, jewelry)
- Business Entities
- Patents and Trademarks
- Digital Assets
Estate Planning Objectives
Specific estate planning objectives may include some additional planning to accommodate issues such as:
- Estate Taxes
- Business Continuity Succession
- Family Business Succession
- Charitable Planning
- Special Needs or Pre-Medicaid
- Generational Planning
- Spousal Planning
- Funeral Expenses and Burial Costs
Conclusion
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 or schedule an appointment with one of our Pro Client Guides for a complimentary consultation based on your own numbers.
