Life insurance is an important part of many people’s estate plan. This could be a single person with a single beneficiary, all the way to a high net worth individual with several businesses and charitable gifting intentions.

Life insurance can be a good solution for a number of things that people commonly want to do in their estate, such as:

• Providing a lump sum or series of payments for a beneficiary
• Paying off the debts of the estate
• Paying the estate tax for high net worth individuals

Paying life insurance premiums while alive is usually cheaper than paying out of the assets of the estate – and easier too, given that assets are often fairly illiquid.

Here are some of the ways, from simple to complex, that people frequently use life insurance in their estate plan. Not all of these are going to relate to you – in fact, maybe none of them will – but this may provide ideas to explore if any of these situations are similar to your own.

Single Person, Single Beneficiary

Let’s take a look at a very simple life insurance for estate planning circumstance: a single person purchases a policy for a particular beneficiary and they would like to replace their income after they pass. That’s a pretty simple need, but it can easily get more complex. For example, if someone names a trust rather than a natural person as the beneficiary, they might work with an estate planning attorney because they have specific objectives for how the money is spent.

A Couple with Children

Another common use for life insurance in estate planning is when a couple is financially stable at the time when one or the other passes, but are concerned that that is not the case for their children. They might use what is called a survivorship life policy, or a second-to-die policy, to make sure that once they both pass, their children’s financial needs are covered. One of the advantages of that type of strategy is that a policy that does not pay until a second named party dies is often substantially less expensive than buying individual policies on both parties.

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Charitable Gifting

Many owners of life insurance also have charitable gifting interests. Let’s say that you have a particular charity that you like giving to, and every year when they have their annual drive, you donate a few hundred dollars. Alternatively, you might choose to take a similar amount and purchase life insurance premium instead, to leverage up your gift at death. The charity will get a much larger benefit when you pass than they would have by receiving those monetary donations directly during your life.

What about when you have a life insurance policy that you no longer need? Perhaps the person that was the named beneficiary has predeceased you, or perhaps they are now divorced from the party for whom you originally purchased the life insurance policy. You don’t necessarily have to cancel it; instead, you can update the beneficiary. The new beneficiary can reflect your charitable interests. This accomplishes two things:

1. It allows you to update your wishes.
2. Rather than buying a new policy to meet that objective, you are able to continue in a policy that may have been acquired when you were healthier or younger, and thus paying lower rates.

Business Owners

Let’s say that two partners own a business together, and they have determined that the value of that business is $2 million. Both would like the other partner to run the business in full when the first party passes. Neither wants their children to inherit their portion of the business and actively manage it. What they would like to happen, however, is that their children receive the economic value of the business, without needing to actively manage it. The remaining partner might not expect to have a million dollars to buy out the heirs of the other partner, so setting up a buy-sell agreement and using life insurance to fund it can be an efficient way to accomplish that goal.

This can be fairly simple when there are only two parties involved. If there are more than two parties are owners, it is usually a better idea for the business itself to own the policies. This way only one policy needs to be purchased on each partner, instead of each partner purchasing a policy on every other partner and vice versa. The two main types of life insurance for this situation are called the “entity” and “cross-purchase” plans.

Although the decision of which general strategy to use is most often based on how many parties are involved, you’ll want to discuss the specific options and advantages of each strategy with a qualified and experienced estate planning attorney and life insurance professional. They can set you up to help you accomplish your goals with a buy-sell agreement.

Pay Estate Tax

I remember watching the news with my grandfather as a kid (actually, he was watching the news. I was waiting for it to be over so I could watch cartoons.) There was a story about the largest life insurance policy ever sold. This was confusing to me because I thought the same thing that a lot of people do: “This person was fairly wealthy. Why does he need a life insurance policy at all?” I learned many years later it was because of the estate tax. Many wealthy individuals wish to use life insurance to pay their estate tax bill.

The estate tax has been in the news lately, now that President Trump’s tax reform has increased the amount of the estate tax exclusion to $11.2 million for a single person and double that for couples. You must have a very high net worth to qualify for the estate tax.

Let’s say that you have a $50 million net worth. You probably don’t have $50 million hidden under your mattress at home or in an easily liquidated checking account. You most likely have several business interests, pieces of real estate, maybe some fine art or other hard assets – things that are either difficult to liquidate, or that you do not wish to liquidate due to their sentimental value or importance to, perhaps, a family business. You would determine what your estate tax liability is likely to be, and then purchase a life insurance policy for that approximate amount.

Here’s the kicker, and why you probably need an estate planning attorney in the mix to accomplish this goal. Let’s say you expect to owe $5 million in estate tax. If you purchase a $5 million life insurance policy directly, the irony of that situation is that now that policy is included as an asset of your estate. Don’t make this estate planning mistake!

What many people often do in this situation is purchase their policy inside what is called an irrevocable life insurance trust, or ILIT. Like all trusts, the ILIT owns the items inside of it. But as an irrevocable trust, assuming other conditions* are also met, it will be excluded from the estate, so it won’t increase an already present estate tax. This would not be the case if it were owned directly.

*Conditions include the length of time the policy must be in the trust and naming an appropriate trustee. Other conditions may apply, depending on circumstances.

Hire Professionals

If you think any of these strategies would be a good fit for you, make sure to retain qualified professionals: an experienced life insurance agent that’s worked on similar cases, as well as an estate planning attorney that has a specialty in that area. Avoid the temptation, not only to use generalists but also to use online sources or templates that you fill in yourself. They may effectively meet their stated objective, but if you don’t know all the available options or exactly what you need, the insight that can come from consultations with seasoned professionals will be lost.

Don’t Forget!

If you do open a trust, remember to fund it. Also, be sure to review and update your trust every year to ensure it still meets your wishes and to remove ex-spouses and people who might have passed.

If you need help navigating life insurance for estate planning to meet your specific needs, don’t hesitate to contact us at Pure Financial Advisors.

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Pure Financial Advisors is not in the business of providing legal advice and/or services. Because our advisors are knowledgeable in estate planning matters, they may at times give general directions as to what estate planning services should be considered. As such, the following should not be construed as actionable legal advice. You should consult with an experienced attorney, preferably with a “Certified Estate Planning Specialist,” before taking any action.

 

About the Author

Financial Educator

CFP®, AIF®

Jason has been involved in the financial services industry as an advisor and financial educator for more than ten years. Prior to joining Pure Financial Advisors, Jason taught in the Financial Planning program at the...