Estate Planning Blog

The Role of Life Insurance in Estate Planning

The goal of an estate plan is to manage and preserve your assets while you’re alive as well as control distribution following your death. Your plan will be unique to you based on your age, lifestyle, health, and wealth. Therefore, there are many aspects to consider in planning your estate. For most people, vital documents will be needed, such as a will, trust, and power of attorney. In some cases, you can use life insurance in estate planning to safeguard many aspects of your plan and provide cash benefits upon your death.

Primary Purposes Of Life Insurance in Estate Planning

Although life insurance is just one of many estate planning tools, it has multiple uses in your plan. The primary purpose of life insurance is to:

  • Replace income that you provide for your family when you pass away.
  • Pay off debts such as a home mortgage, credit cards, car loans, student debt, funeral expenses and final medical bills.
  • Provide for your spouse and/or children:  living expenses, education, and other needs.
  • Pay taxes such as estate taxes, income taxes on tax-deferred accounts like IRA’s, and capital gains taxes. This can avoid having to liquidate assets, and also save your family from and enormous financial burden.

Life insurance is not just an investment for those who are living; it is an essential tool to use when planning your estate. As part of the estate planning process we advise our clients as to whether or not they have sufficient life insurance.

A common misconception about life insurance is that it is not taxable to your heirs. There is no income tax on life insurance proceeds, however, life insurance is part of your estate for calculating estate taxes. There are estate planning options available to make your life insurance both income tax and estate tax free.

Types of Life Insurance

There are two main types of life insurance that might work for your needs: term and permanent. Both offer a death benefit, but permanent life insurance also provides cash value.

Term Life Insurance

Term insurance provides protection for a certain time period, or term. You may choose 10 years, 30 years, or somewhere in between, based on your needs. Once the term ends, so does the coverage, and you won’t have any of the money you put into the policy. If you die before the end of the term, the the policy proceeds will be distributed to your heirs. However, most companies will not offer term insurance to individuals above a certain age, and most term policies end by the time the policyholder is 80.

Permanent Life Insurance

The options for permanent life insurance include whole life, universal life, variable universal life, and indexed universal life. These policies last from the time of purchase until the policyholder’s death, or until a set age, often 90 and beyond. Permanent life insurance policies include a savings account in which cash value is accrued that can be accessed while the policyholder is alive by borrowing against its value. This is also a benefit for heirs since permanent life insurance provides a death benefit and cash value. For estate tax planning permanent life insurance is generally the better option over term insurance.

The Benefits of an Irrevocable Life Insurance Trust

To really leverage life insurance in estate planning, one option is to create an irrevocable life insurance trust (ILIT). The ILIT purchases a life insurance policy, either for an individual or couple. When the expectation is that the estate will be taxed, an ILIT is a strategy to pay for those estate taxes, as well as any other expenses, without the need to liquidate assets. Life insurance proceeds payable to an ILIT are not taxed.

Determining if an ILIT is the correct choice for your estate plan is something that you should discuss with your estate planning attorney. If you feel that your estate may owe estate taxes, it’s advisable to at least consider incorporating an ILIT into your estate plan. This may become a critical strategy as the federal government continues to toy with ways to raise the estate tax rate and lower the exemption.

Remember that Tax Laws Are Changeable

In 2021, the exclusion for estate tax at the federal level was raised to $11.7 million per person or $24.4 million for a married couple. California, on the other hand, doesn’t have a state estate tax and hasn’t since 1982. You may then wonder how adding life insurance in estate planning will benefit you and your heirs. Remember that, although these are the limits now, these tax rules will change in the future. Even if the fed does not change the current tax structure, it is set to expire at the end of 2025, and the estate tax exemptions will drop by 50%, so when considering the role of life insurance in estate planning, it’s important to look at your long-term strategy as opposed to what is a good fit in the short term.

What if you already have Life Insurance?

It is important to review existing life insurance policies to determine if you have adequate coverage. Many of our new clients are very uninsured, but we also meet with clients who are paying for insurance they do not need.

It is also critical to know that the cost of insurance has come down over the years, making it possible to rollover your policy into a new policy that will cost you much less, or even create a policy that will allow you to stop making payments altogether. Older policies should always be reviewed by an expert insurance broker. If you do not have a broker we are happy to refer you to a top agent.

Should You Incorporate Life Insurance in Estate Planning?

Whether you already have an estate plan or are in the process of creating one, adding life insurance in estate planning may be a smart way to ensure your heirs have liquid assets to cover expenses upon your death. Contact us to learn if this is the right option for you. Whether you have a plan in place now or need to start from the beginning, we can help. Contact us so we can get started and protect your assets – the time to act is now. For over 30 years Joel A Harris has been protecting the estates of families throughout California. To schedule your consultation visit us online, in person or call us by phone at (925) 757-4605.

Request a Consultation

This field is for validation purposes and should be left unchanged.