Navigating Life Insurance for Estate Planning

Life insurance protects your loved ones against financial expenses when you pass away. It can also help you pay for the estate taxes of a deceased member of your family. Some may be unaware of the benefits and strategies that can be implemented to maximize such advantages. MoneyGeek explains how life insurance can be used in estate planning and provides tips.

Survivors are often tasked with sorting through the assets and liabilities of a deceased person while they are grieving. Using life insurance for estate planning can alleviate some of the difficulties, providing financial support to family members and business asset coverage.

Utilizing life insurance to cover estate taxes can be a strategic approach. Federal estate tax applies to the gross estate of the deceased and must be paid within nine months after the death of an owner. Some states also impose estate taxes. Proceeds of life insurance are often tax-free.

Choosing universal life insurance gives you access to an investment savings component. Depending on the terms of your policy, you can also borrow the cash value as a financial cushion in case your business encounters problems. Additionally, life insurance can serve as collateral for a business loan or fund a buy-sell agreement. Buy-sell agreements set prices and terms that surviving partners must follow to purchase the shares of the deceased or leaving partner. If you die, surviving owners will receive death benefits, and your family will get payment for your interest in a company.

Expenses related to the death of a person include funeral and burial costs, possible debts and taxes. Liquidating assets can take time. On the other hand, the death benefit of a life insurance policy can be claimed immediately, making it useful for paying out such expenses and reducing the financial burden of a death on your family.

Having more than one heir to an estate can lead to complications. When it is difficult to split up assets, conflicts may arise. Additionally, there are cases when breaking up an estate can reduce its ability to generate revenue. In such instances, life insurance can be used to equalize estate inheritance. For instance, one heir may receive property while another may receive the death benefit proceeds of the insurance policy.

As the owner of a policy, you have the option to choose how the proceeds of your insurance will be used. For instance, you can continue supporting a loved one even after your death, which is especially helpful for aging adults, minors and children with disabilities. Others may use it to continue alimony or child support payments, or fund a trust for another purpose. With a trust, you can hold assets on behalf of your beneficiary under the supervision of a trustee.

Generally, life insurance plays three main purposes in estate planning. First, it provides death benefits to chosen beneficiaries. Second, it provides liquidity that can be helpful with an estate. Lastly, it allows loved ones to obtain financial support. To effectively integrate life insurance into estate planning, it's essential to explore various strategies that amplify these benefits.

The value of an estate can rise or fall depending on federal and state taxes. Estate taxes are due nine months after the death of the owner. Savings, investments, loans and liquidation can all help settle an outstanding balance. However, such tools may not be enough. In reality, life insurance can be one of the most advantageous ways to alleviate the financial burden of paying an estate tax. Proceeds will be given to your beneficiaries, and insurance payouts are often tax-free. The following resources can help you learn more.

• Internal Revenue Service: The IRS can answer some of the most common questions about estate tax issues, including what is included in an estate, if you are required to file, when you can expect an estate tax closing letter and what happens if you sell property that you’ve inherited.
• Tax Foundation: The Tax Foundation is an independent tax policy nonprofit that provides research and analysis. It works on state and federal tax policy to educate Congress, politicians and others about the short and long-term impact of reform.
• NOLO Legal Encyclopedia: The encyclopedia provides a primer on the states that have appealed estate taxes, the states that impose estate taxes and many other relevant issues.
• Congressional Budget Office: The Budget Office offers a helpful guide to understanding estate and gift taxes, including the types of people who pay them and the types of assets that make up taxable estates.
• American College of Trust and Estate Counsel: ACTEC regularly updates a state death tax chart, which you can consult to find out more information about the laws that apply in your state. The chart shows whether a tax is tied to a federal state death tax credit or if an estate tax has been repealed.

Deciding on the inheritance to leave behind to each of your heirs can help protect against fallout after someone passes away. Assets like businesses and residences may have multiple owners, which is where life insurance comes in. That’s because death benefit proceeds can be used to balance the value of assets. For instance, you can leave behind your business to one child and give death benefits to another. Life insurance can also be used to equalize distribution to heirs using your business. For example, you can have a buy-sell agreement wherein the company buys a life insurance policy that will pay a benefit to participating heirs upon your death.

Being the breadwinner of a family comes with many responsibilities. A family may depend on you for expenses, and your death may lead to the loss of significant income. With life insurance, you can continue supporting your loved ones through the proceeds of your policy. Depending on the type of policy you choose, you can use insurance as income replacement or coverage for unexpected expenses like medical costs or debt payments. You can also turn your insurance into retirement income by surrendering the cash value or executing an exchange into an annuity.

If you aim to use life insurance in estate planning, an irrevocable life insurance trust (ILIT) can be created to control either a term or permanent insurance policy while a policy owner is still alive. With an ILIT, you can transfer your policy to the trust or use the trust to purchase life insurance, which means the trust owns your insurance policy. The trust document will determine who will administer assets, designate beneficiaries and establish terms on how beneficiaries receive benefits.

An ILIT removes a life insurance policy from your estate, helping you minimize or even eliminate your estate tax liabilities on assets that do not qualify for a charitable or marital deduction. It can also help with the management and distribution of proceeds upon the death of the insured by immediately providing liquidity for the decedent’s estate and estate beneficiaries.

An Irrevocable Life Insurance Trust comes with a variety of advantages and drawbacks. For example, an ILIT is a great option if you want to set aside your assets for specific purposes, but you may be responsible for paying gift taxes if a beneficiary withdraws from a trust. Make sure to weigh all the pros and cons before deciding to create one.

ILITs can help with wealth management and estate planning. However, they may not be the best option for everyone. Keep in mind that the trust agreement under an ILIT is irrevocable. That means you can no longer change the terms once they are in effect. If you think the terms may cause problems in the future, consider alternative options, such as choosing an entity to own the life insurance policy, giving a policy as a gift to ensure that it is out of your estate or making your child the insurance policy owner.

Estate planning requires proper preparation. The same approach may not be applicable for everyone, so take a look at the particulars of your situation, conduct your own research, consult with professionals and learn about all possible options and alternatives. Understanding the interplay between life insurance and estate planning can illuminate various options and alternatives tailored to your needs.

It’s vital to learn how to recognize estate planning challenges. To prevent incurring losses and ensure that you are getting the best available option for you and your heirs, pay attention to family members with disabilities, blended families, family-owned businesses and spouses.

The decisions you make about estate planning will impact the lives of your loved ones after you pass away. It’s important to consider your assets and liabilities, speak to your family and consider life insurance. A do-it-yourself approach can work fine, but always look at the possibility of hiring law professionals and getting advice from financial advisors or insurance agents. Taking time to investigate the entirety of the process can help you avoid making costly mistakes.

Navigating the intersection of life insurance and estate planning raises numerous questions, from how policies impact estate distribution to the role of beneficiaries. Understanding these nuances ensures that your planning efforts align with your intentions for your loved ones' future.

A variety of resources can help you learn more about estate planning, life insurance and ILITs and make a plan for the future.

• American Bar Association: The Bar Association is a voluntary association composed of lawyers from all over the world. It provides information on various laws in various jurisdictions, and it also gives access to a directory of lawyers.
• Better Business Bureau: The Better Business Bureau provides a search tool which allows consumers to find information about insurance companies, including trustworthiness ratings and customer complaints.
• Coalition Against Insurance Fraud: The Coalition gives a list and access links to different state insurance fraud bureaus to help consumers easily get help or report fraud scams.
• Council of Parent Attorneys and Advocates (COPAA): COPAA is an organization that is composed of special education lawyers, advocates and families that aims to help support and educate parents with children with disabilities.
• National Association of Insurance Commissioners (NAIC): NAIC is a non-partisan organization that provides regulatory support to create standards in the insurance industry.
• USA.gov: USA.gov is a government website that provides information about various federal laws and regulations, including those on estate taxes and insurance.