Expert Opinion: The Role of Life Insurance in Estate Planning

Life insurance can be a key component of estate and multigenerational wealth planning, especially for high-net-worth households. But as with many other things, the devil’s in the details. We start by defining what role, if any, life insurance can play in a client’s estate plan, and also the logistics of ownership so that the policy has the intended effect. Kristi Mathisen, LNWM’s Managing Director of Tax and Financial Planning, recently spoke with MoneyGeek, offering expert insight on this important topic. Here’s what she had to say:

Why is life insurance an important component to estate planning?

Life insurance can provide the liquidity needed to meet the decedent’s or decedent’s estate obligations, including paying off debts and providing financial support for remaining family members in the event of an untimely death. Insurance proceeds can also provide cash to pay taxes when the estate is comprised of mostly illiquid assets that can’t be quickly sold at favorable prices or be a source of funds to equalize uneven bequests to beneficiaries. In a business setting, life insurance can also facilitate payments needed by the business or the surviving owners to fulfill buy/sell agreements when another owner has died.

What type of life insurance is best for estate planning? What special considerations should you take into account when choosing a type of life insurance?

There’s no one-size-fits-all answer. What type of insurance is “best” requires considering how it will be used, how much it costs and what flexibility the family needs. For example, term insurance is appropriate when the need is temporary. Caring for dependent children may fit into this category since, as children age, the need for financial support may decrease just as premiums are about to go up. Term insurance can let families buy just the amount of insurance needed – and get rid of it when it’s not.

Permanent insurance – such as whole life, universal or variable universal policies – has an investment component that can help keep premiums consistent over time, making it more appropriate for long-term needs. Consider an insured person who develops health issues as they age. When that happens, they may become harder and more expensive to insure, and having long-term insurance can help mitigate that risk. In addition, the investment element of permanent insurance grows income tax-free.

How can you maximize the use of life insurance in estate planning?

There are two primary considerations in maximizing life insurance in estate planning. The first is whether you actually need life insurance. The second is, if you do, making sure the right people own it and get the proceeds at death.

A family with independent adult children, a comfortable financial situation and sufficient liquid assets to pay taxes due on the estate doesn’t really need insurance. It may be “nice to have” because there will be extra assets at death, but it’s not necessarily a need.

Making sure the right person owns the insurance is far more important – and this is often not the case. Remember, everything a decedent owns is part of the estate. If they own life insurance on themselves at death, the proceeds are part of the estate and, if the insurance is owned for the purpose of paying estate taxes, the taxes due could actually go up. And it’s vitally important that the beneficiary designation for life insurance be reviewed by an estate planner to ensure (no pun intended) that the beneficiary of the insurance is the correct party for the estate plan.

When is the right time to use an irrevocable life insurance trust?

The right time to use an irrevocable trust is when the inclusion of life insurance in the estate of the decedent either causes or increases the estate tax itself or when the decedent may have creditors that would claim the proceeds that are needed for other estate purposes. But, while an ILIT can offer some protection, it doesn’t come without responsibilities. The insured must be prepared to meet the financial requirements of having an ILIT, which means making timely gifts to the trust to pay insurance premiums and the administrative costs of the trust. And, the proper formalities must be observed: The insured cannot be the trustee, the payments of premiums must be paid from the trust, and often notices of gifts to the trust must be given to the beneficiaries to secure certain tax benefits.

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