Planning with Life Insurance

In this post, I discuss some techniques for estate planning with life insurance, the benefits it can offer, and how it can help address estate tax issues.

*Photo by funeral insurance is licensed under CC 2.0. *

In a previous post, I discussed the basic principles of life insurance and how it can play a part in your estate plan. In this post, I will more fully discuss planning with life insurance. The main object of such planning is to fully integrate the policy into your larger estate plan.

Life Insurance and the Estate Tax

If your estate is worth more than the estate tax exemption—$5,250,000 as of 2013—or two estate tax exemptions if you are married, estate tax issues generally should not be a great matter of concern when planning with life insurance.

You should, however, ensure that the beneficiary designation is done correctly to avoid otherwise inapplicable estate tax issues. A failure to properly plan may result in the subjection of life insurance proceeds to the estate tax.

Providing For Minors

When dealing with minor children, it is a good idea to name a trust for the children’s benefit as the beneficiary of the life insurance policy. I have encountered many people who simply want to leave their life insurance proceeds to a parent or sibling with the understanding that the money will be used to take care of their surviving children.

This, however, is generally not a good idea. Leaving life insurance proceeds to your children’s guardians makes those proceeds theirs. They can do whatever they want with the money, and you never know when someone you trusted will later violate that trust.

Nobody wants the life insurance they purchased to pay for their kids’ education to end up remodeling their sister’s kitchen—or simply to pay off a relative’s credit cards. While this may seem unlikely, it is important to realize that this is in fact a possibility. If it happens, there is little your children will be able to do about it because it is not their money being spent.

The beneficiary of a life insurance policy owns the proceeds once paid out, and you never can know what will happen after you die. Forming a testamentary trust is not difficult, and it can provide a significant advantage to your children. It can help ensure that those proceeds are theirs and cannot be squandered by a guardian without significant legal consequences.

Money has a way of changing people. Placing life insurance proceeds into a trust can simply remove the temptation to dip into the money, particularly when a large amount is involved.

Planning with Life Insurance

If you have an estate worth more than your available estate tax exemption, it is a good idea to have someone other than you own the policy to avoid its being included in your taxable estate at death.

Keep in mind, however, that if you were originally on the policy but then transferred the policy to someone else, the policy can be pulled back into your estate if you de within three years of the transfer. This is where the irrevocable life insurance trust, or ILIT, which I will discuss in a future post, becomes particularly valuable.

In addition, gifting a policy must be done carefully, as there may be gift tax consequences. A gift of the policy will be valued at the cash surrender value—which is generally applicable to whole and universal life policies. In addition, whenever the insured makes a premium payment on a policy he or she does not own, there is a gift.

Noninsured owners should be designated as the primary beneficiary of the policy to avoid further estate tax implication. It is also important to designate a contingent beneficiary to prevent the proceeds from being paid to—and thereby included in—the estate of the insured at death.

The estate plan should provide who should get ownership of the policy if the owner predeceases the insured. This can be done through the owner’s will.

Life insurance can play an important role in most estate plans. Therefore, proper planning with life insurance is critical to ensuring that your desires are met.

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See Also:

Life Insurance

Irrevocable Life Insurance Trust (ILIT)