In the event of your death, a life insurance policy ensures that your family has the financial resources to maintain their standard of living. This is the number one reason why individuals consider life insurance. Although it’s the number one reason, it’s not the only reason. Life insurance can also be an essential estate planning tool and help protect your legacy. Below are a few roles life insurance has in estate planning:
- Provides Financial Security for Loved Ones: Life insurance provides financial security for your beneficiaries. This can be particularly crucial if you are the sole income earner of the household. Life insurance proceeds can help cover funeral costs and other debts your family may incur and provide a temporary income stream to cover future living expenses.
- Pays Estate Taxes: The Federal estate tax is currently 40%. This can significantly reduce the value of the assets you leave to your heirs. Life insurance can provide the liquidity needed to pay these taxes.
- Equalizes Inheritances: Having multiple heirs can be challenging when deciding how to divide your estate equally and fairly when the assets are illiquid. Life insurance can be used to simplify this process. For example, if one child inherits the family home, a life insurance policy can provide an equivalent cash benefit to another child, ensuring your estate is fairly distributed.
Which life insurance policy is best?
It depends. The two most common life insurance policies are term and permanent. When deciding between term and permanent life insurance, the following factors should be considered:
- Financial Goals: Term Life Insurance is best for temporary coverage needs and those seeking affordable, high-coverage protection. The term usually lasts 10 to 30 years, and if you die before the term is up, your beneficiaries will receive the death benefit. Permanent Life Insurance is best for long-term financial planning and those wanting a policy that builds cash value. Cash value is the financial planning aspect of the policy as it grows over the policy. The growth of the cash value is tax-deferred.
- Budget: Term Life Insurance tends to have lower premiums than Permanent Life Insurance.
- Coverage Duration: As mentioned above, Term Life Insurance lasts for a specific term, typically 10 to 30 years. This makes Term Life Insurance best suited for temporary needs, such as providing for minor children or paying off a mortgage. Permanent Life Insurance is appropriate for lifelong needs, such as ensuring estate liquidity or providing for lifelong dependents.
Who should own the policy — an individual or a trust?
It depends. Death benefits of a life insurance policy will generally be included in your taxable estate when you own the policy individually. This may not be beneficial from a tax perspective if you have a taxable estate. If you have a taxable estate, you can transfer the policy into an irrevocable trust, otherwise known as an irrevocable life insurance trust (ILIT). There are several considerations when choosing ownership:
- Estate Size and Tax Liability: If your estate is large and likely subject to federal and/or state estate taxes, owning the policy through an ILIT can help reduce the taxable estate. For smaller estates, individual ownership may be enough.
- Control and Flexibility: Owning the policy individually will allow you to maintain control over both the policy and its benefits. However, if you want to ensure the proceeds are managed in a specific way after your death, a trust may be more in line with your goals.
- Beneficiary Needs: If your beneficiaries are minors, have special needs, or are not financially savvy, a trust can help manage the proceeds more effectively and ensure they are used appropriately.
There are several types of life insurance policies. Choosing the right one and deciding who should own the policy is essential and depends on your specific financial situation. Our team of experts has over 90 years of combined experience in estate planning and our primary goal is to assist individuals and their attorneys to effectively transfer wealth while minimizing unnecessary estate, gift, and generation-skipping taxes. Contact us today to ensure a smooth transition.
Sources:
https://www.schwab.com/learn/story/should-you-add-life-insurance-to-your-estate-plan
https://www.linkedin.com/pulse/role-life-insurance-estate-planning-rick-breed-sl6me/
https://cricpa.com/insight/life-insurance-estate-planning/
https://www.protective.com/learn/four-ways-to-use-life-insurance-in-estate-planning
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About the Experts
Richard Umanoff, CPA, MBA, Principal
Tax, Estate & Gift, Trust and Probate
Richard Umanoff is an Estate & Gift, Trust and Probate Principal at KROST. Richard’s career spans over 45 years, with a concentration in taxation. His primary emphasis is estate and trust tax compliance, planning, estate administration, and probate court accounting. Richard currently serves in the role of trustee for numerous clients. » Full Bio
Douglas A. Venturelli, Esq., Principal
Tax, Estate & Gift, Trust and Probate, Sports & Entertainment
Douglas A. Venturelli is an Estate & Gift, Trust and Probate Principal at KROST. He has over 45 years of experience in tax, estate, and business services. His main focus is federal estate and gift taxes. Doug consults with clients in the entertainment, legal, real estate, and medical industries. » Full Bio
So Sum Lee, CPA, Principal
Tax, Real Estate, Hospitality, Estate & Gift, Trust and Probate
So Sum Lee is a Tax Principal at KROST. So Sum has over 25 years of experience in public accounting and has a wide range of experience in Taxation, as well as servicing high-net-worth clients. So Sum’s area of expertise includes industries such as wholesale, real estate investments, and restaurants. » Full Bio
Kimberly Hoang, CPA, Senior Manager
Tax, Estate & Trust, Gift and Probate
Kimberly Hoang is a Senior Manager in the tax department at KROST. She has been in the public accounting profession for over four years. Her areas of focus include tax planning and compliance for small to medium-sized businesses – sole proprietorships, partnerships, corporations, and high-net-worth individuals. » Full Bio