Use Life Insurance in Estate Planning to Treat Beneficiaries Equally

Life insurance in estate planning is a common tool as it provides liquidity in an estate.

Life Insurance in Estate Planning for Estate Equalization

That liquidity can be used to pay estate taxes or to equalize an estate. By equalize, we mean to make sure that each beneficiary gets the same amount, say in the case of children.

Let’s say Mr. Smith has two sons. Son 1 works with him in the business and wants to take over the business when dad passes. The business is worth $5 million. Mr. Smith will leave the business to Son 1. Son 2 has no interest in the business. So how can Mr. Smith treat his sons equally in his estate plan?

The answer is to use life insurance in estate planning. Mr. Smith purchases a life insurance policy payable to Son 2 for $5 million. Each son then inherits an asset worth $5 million in this simplified example.

But what if Mr. Smith has a heart condition and he cannot get life insurance; he is uninsurable. He can still use life insurance in estate planning.

One answer is to obtain a joint policy with Mrs. Smith. Often called survivorship policies or second-to-die policies, these policies insure two people. But the insurance company bases the issuance of the policy on the healthier of the two parties.

So even if Mr. Smith is uninsurable due to medical conditions while Mrs. Smith is in fair to excellent health, the insurance company will place their “bet” on Mrs. Smith as the policy pays off when the second of the two insured parties die. And since Mrs. Smith looks sure to outlive her husband, the insurance company is really taking their risk on Mrs. Smith.

What if Mr. AND Mrs. Smith are both in poor health and uninsurable. There is still an opportunity to use life insurance in estate planning.

Does Mr. or Mrs. Smith have any siblings about their same age? If so, are these people insurable? If these siblings are amenable, they can have the insurance placed on their life payable to Smith Son 2.

The reason this makes sense is that Mr. Smith’s objective is that each son gets the same amount of assets “around” the time of his death. If Mr. Smith is 70 and he has a brother is 72, they have similar life expectancies. If the insurance is placed on the brother, Son 2 will receive the $5 million at the death of his uncle (rather than at the death of his uninsurable father). But Mr. Smith’s objective is attained this way.

The point here is not to get hung up on the health or insurability of a specific person. Look to see if there are other relatives of the same age group that is insurable to pursue an estate planning objective.

Also be aware that insuring the uncle may bring up an “insurable interest” question by the insurance company. A person has an “insurable interest” in something when loss or damage to it would cause that person to suffer a financial loss or certain other kinds of losses. For purposes of life insurance, everyone is considered to have an insurable interest in their own lives as well as the lives of their spouses and dependents.

But Son 2 does not have an obvious insurable interest in the life of his uncle. However, if the facts are presented to the insurance company and the family’s overall objective to equalize an estate for the next generation, the insurance company will likely accept this arrangement.

Life Insurance In Estate Planning for Estate Liquidity

At your death, estate taxes need to be paid (if you owe estate taxes). Currently, in 2018, it is not likely you will owe estate taxes and only those with estates over $5.6 million do.  However, Congress changes this threshold every few years so you could owe estate taxes in the future.

Additionally, your State may levy an inheritance tax on your beneficiaries. Where will beneficiaries get the cash to pay the tax?

If you are married and you pass, any estate taxes may be delayed until your spouse’s death. Other costs such as funeral expenses, debt settlement, and administration fees can add to the need to have immediate cash at death and life will insurance provide that liquidity. Other than cash on hand, no asset can provide such a predictable and immediate influx of dollars to pay the costs incurred or supply the liquidity needs as can life insurance.

Perhaps, to pay estate taxes, liquidation of your investments or business may not be timely and produce a substantial loss in value. To maintain intact your investment holdings or business so you can pass them on to your children, you or your spouse may purchase life insurance as, possibly, a more economical option to having to liquidate your holdings.  Why sell assets when a simpler supply of cash can be available?

If you are married, survivorship life insurance generally is used to provide liquidity for final expenses when the second one of you dies.

Life Insurance In Estate Planning for Charitable Bequests

You can combine charitable giving with life insurance to make the donations you always wanted to and you can do this without reducing assets you want to pass on to your beneficiaries.

Here is how it works…
You can – if you have the wealth – give a substantial lifetime gift of appreciated property to a qualified charity. This gifting generates a significant tax deduction. With the income tax savings, you get from this deduction, you can purchase life insurance – whose proceeds at your death will replace the wealth that you gave to charity.  That is, the life insurance proceeds will go to your children (tax-free)

Policy Owned Outside Your Estate

In both these examples, if you maintain ownership of the life insurance, then its death proceeds will be added to the value of your estate. This, in turn, will add to the estate tax on your estate. The simple solution is to have the policy owned by family members.

The fact that life insurance proceeds are free of income tax does not alleviate its contribution to your estate tax. You can keep the life insurance that is on you out of your estate by either giving away ownership of it – at least three years before your death – or by having some other person or legal entity purchase it and own it in the first place. In that case, the insurance proceeds may still be used for paying all those final expenses but would not add to your estate tax. Trusts are common legal entities for purchasing and owning life insurance in such circumstance.

For any beneficial use of life insurance in your estate,  an agent experienced with life insurance in estate planning can help.

 

Traditionally, life insurance is purchased during your working years to replace your income for your family in case you die. But if you’re retired, do you still need senior life insurance? Maybe.

Three Reasons to Own Senior Life Insurance

1. Many couples are dependent upon two social security checks or two pension checks for their retirement expenses. When one spouse passes away, the other spouse finds that the income falls yet many of the expenses and lifestyle requirements remain. The inexpensive way to protect against this scenario is to own term senior life insurance.

Recently, I obtained a $100,000 policy for a 70-year-old male for a premium of $200 monthly. If he predeceases his wife (women statistically outlive men by 7 years), his wife will receive this $100,000. Invested for income at 5% (a hypothetical rate), this would produce $5,000 annually of income. This will offset the loss of his social security check. If used up over her lifetime, (assumed to be another 7 years), the principal plus interest would generate over $15,000 annually for the wife.

2. Some people maintain senior life insurance for estate planning reasons. Let’s say you’ve developed your net worth by owning real property. One son takes an active interest and manages most of your property. The other son lives 2,000 miles away. He travels around the globe as an archeologist and has no interest in the properties. You want to leave the properties to the son who cares for them. But  you are concerned what to leave the other son. Easy answer. Buy life insurance and name the archeologist as the beneficiary.  The life insurance policy should be equal to the value of the properties so each son gets an equal amount.

If your estate is over $5.45 million, the excess is subject to estate taxes at hefty rates. A simple, often inexpensive way to pay the tax without taking money from the beneficiaries is to have a life insurance policy to pay the tax.

3. To make the most of your IRA or retirement plan. Say you are age 70 and it’s time to start taking mandatory distributions from your IRA. Let’s assume the distributions are a hypothetical $15,000 annually. If you invested those distributions at a hypothetical 8% (5.2% net after combined taxes of 35%), you would accumulate $190,439. Take the same $15,000 and buy senior life insurance and upon death your heirs get $1.25 million. That’s a lot more than the $190, 439 you would accumulate. You can do the same if you have a qualified retirement plan but the numbers are even better as you can purchase the policy inside the plan with pre-tax dollars.

By the way,  don’t be concerned about health.  For estate purposes, senior life insurance can be written on a spouse or any relative about your same age. An insurance agent can explain that.

How to Turn a Life Policy You No Longer Need into Cash or Income

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These are some very powerful ways to use a policy you already own.  Or you can get a new policy to achieve financial goals for your family.

Now assume you have a life insurance policy and have no reason to keep it.  You have several choices to turn it into cash or into income:
• You can withdraw your basis in the policy free of tax. The basis is the amount of premiums you paid less any withdrawals you have made. This would still maintain the policy but get your cash out.
• You can take a policy loan. Loans are not generally taxable because they are an advance of the death benefit.
(Remember that taking cash from your policy will reduce or eliminate your death benefit.)

You could also sell your policy for cash to a third party but we discuss this in a separate post. You can sell a cash value policy and potentially, even a term policy in which has no cash value.

You may want to terminate it all together. Most cash-value policies offer three non-forfeiture options if you want to terminate your policy before maturity:
1. You can receive the policy’s cash surrender value in a lump sum, or
2. You can use the lapsed policy to continue to provide death protection at the net rate for term insurance, or
3. You can buy a paid-up term or cash-value policy for a reduced face amount using part of the cash surrender value of the policy and keep the rest for your use.

You really need to talk with an agent to go through these options if you have a policy you no longer need.

 

Life insurance can help you achieve some of your estate planning objectives. Let’s see how.

Get cash for settling estate costs and preserving your holdings intact:
At your death, estate taxes need to be paid. If you are married, these may be delayed until your spouse’s death. Other costs such as funeral expenses, debt settlement, and administration fees can add to the need to have cash.
Life insurance can supply this cash. Other than cash on hand, no asset can provide such a predictable and immediate influx of dollars to pay the costs of dying as can life insurance.
Perhaps, to pay estate taxes, liquidation of your investments or business may not be timely, and produce a substantial loss in value. To maintain intact your investment holdings or business, so you can pass them on to your children, you or your spouse may purchase life insurance as, possibly, a more economical option to having to liquidate your holdings.

If you are married, survivorship life insurance generally is used to provide liquidity for final expenses when the second one of you dies.

Make that charitable gift and still transfer your wealth to your children
You can combine charitable giving with life insurance to make the donations you always wanted to. And you can do this without reducing the wealth you want to pass on to your beneficiaries. Here is how it works…
You can-if you have the wealth-give a substantial lifetime gift of appreciated property to a qualified charity. This gifting generates a significant tax deduction. With the income tax savings you get from this deduction, you can purchase life insurance; whose proceeds at your death will replace the wealth that you gave to charity.

Foregoing ownership of life insurance will further reduce your estate taxes
In both of these examples, if you maintain ownership of the life insurance, then its death proceeds would be added to the value of your estate. This, in turn, would add to the estate tax on your estate. The fact that life insurance proceeds are free of income tax does not alleviate its contribution to your estate tax. You can keep the life insurance (that is on you) out of your estate by either giving away ownership of it-at least three years before your death-or by having some other person or legal entity purchase it, and own it in the first place. In that case, the insurance proceeds may still be used for paying all those final expenses, but would not add to your estate tax. Trusts are common legal entities for purchasing and owning life insurance in such circumstance.