(by Jordan Johnson)
Researching life insurance strategies for estate planning is important for your estate to gain tangible benefits and the financial security of your loved ones.
There are many ways to create an estate, with life insurance often being used to supplement larger estates. That said, low-cost life insurance can ensure everyone can leave something behind.
Using Life Insurance as an Estate Planning Tool
A well-designed life insurance policy can provide excellent benefits when estate planning. Consider some of the following reasons a life policy can help you create an estate.
Providing Fast-Access Cash for Death Expenses
Estates of any value can benefit from life insurance coverage, from those worth very little to those with millions of dollars in assets.
When someone dies, there are often a number of expenses that come with it. These expenses include but aren’t limited to:
- Funeral expenses.
- Mortgage or credit payments that haven’t been tied up.
- Federal estate tax costs that need to be paid within nine months.
- State inheritance and estate taxes.
Unless there are liquid assets in the estate, the urgency to get cash together after a death could cause heirs to sell assets in a rush, often for less than fair value. They could also end up having to sell valuable family assets such as homes, businesses, or heirlooms.
Having sufficient coverage means heirs can use a death benefit to settle all the above expenses without having cash sitting around in an estate doing nothing.
Irrevocable Life Insurance Trusts
An irrevocable life insurance trust (ILIT) is a specific trust that is used to protect a life insurance policy from various taxations, such as estate or gift tax, as well as an estate planning tool for distribution of the death benefit.
Gifts made into the trust, usually sent by the person insured, are final and managed at the trustee’s discretion. It is also important to understand even policies transferred into a trust are made at the mercy of the three-year rule.
Trusts are also a good solution when the beneficiary may not have the capacity to be the policyholder, as missed payments on insurance could result in the policy being canceled.
Finally, if the beneficiary receives any government benefits such as disability income or Medicaid, the life insurance payout can be made in installments managed by the trustee to ensure the death benefit does not interfere with regular government benefits.
Ensuring You Leave an Inheritance to Your Loved Ones
Leaving an inheritance to loved ones isn’t just for the rich.
Aside from covering your death expenses, life insurance is an affordable way to ensure you leave something to your loved ones, especially if you happen to pass on earlier in life.
In addition, the death benefit is almost always tax-free for the heir and won’t ever count towards their gross income for the tax year.
Who Should Own the Life Insurance Policy?
It’s essential to think about who will own the policy, as when the insured dies, if the policy is still in their ownership, the sum of the death benefit will be added to their estate and subject to any applicable taxes.
The policyholder is also the entity responsible for making payments on the policy and naming any beneficiaries.
Typically, to avoid paying gift tax, if the insured isn’t the policyholder, the policy should be with the intended beneficiary or in an ILIT and transferred at least three years before the insured passes.
Succession Planning Through Buy-Sell Agreements
A buy-sell agreement, sometimes known as a buyout agreement, is a document that allows one party to buy out another person’s shares of an asset or business in the event that another partner dies.
Buy-sell agreements work as an effective estate planning tool for business partners who want to be assured that a business can keep running as best as possible after a partner dies.
When using life insurance as a vehicle for a buy-sell agreement, each holder of an asset takes out an insurance policy on the other holders, and the life insurance payout is used to pay for the deceased’s shares.
The agreement gives any heirs of the deceased’s estate cash at a fair market value instead of assets that they may not want to take responsibility for.