Life Insurance in Estate Planning
Life Insurance in Estate Planning
Using life insurance in estate planning is one of the most common and effective ways to ensure loved ones are financially taken care of after your death. Life insurance has many advantages, including that it is relatively easy to acquire and also can offer tax-free protection for beneficiaries.
Before we get to what life insurance is and how it works, it's important to understand the basics of estate planning. Then we can discuss why using life insurance in estate planning is a usually a smart choice.
What Is Estate Planning?
Estate planning is the general term for getting your financial affairs in order before your death. Estate planning documents may include a last will and testament, living trusts, advance health care directives, and others. Your “estate" includes all of the real and personal property you own at the time of your death.
What Is the Estate Planning Process?
The estate planning process involves deciding where you would like your property to go upon your death. You should also figure out who you would like to handle your estate and your affairs should you become incapacitated before your death.
While legal advice is not required when devising your estate plan, there are some issues for which an experienced estate planning attorney could be of great assistance. One of those is the potential for estate taxes, which are taxes to be paid by the estate for the right to transfer property upon death. A well-designed estate plan should help you reduce or avoid paying estate taxes altogether.
How Does Life Insurance Work?
The owner of a life insurance policy pays premiums for the term of the policy and then, upon the death of the insured, life insurance proceeds are paid out to the beneficiaries who are named in the policy.
You can buy a life insurance policy through a broker or directly from an insurance company. Many employers and unions offer group life insurance policies as well, which can be an attractive option for those with health issues, as a medical exam is not usually required as part of the process to qualify for coverage.
Life insurance is especially important for anyone with dependents, especially children under the age of majority, but can be valuable for anyone. For older people whose children have grown, life insurance can be a good way to set aside extra money for funeral costs, unexpected long-term care or other medical expenses, or to help take care of a surviving spouse.
What Are the Different Life Insurance Types?
The two main types of life insurance are term, and permanent, which may also be called whole life or cash-value life insurance:
- Term Life Insurance is a life insurance policy that lasts for a specific period of time, usually from one to thirty years. Because it pays only if the insured dies during the term of the insurance, it is the most affordable, and you can choose the term that best suits your needs; for example, until you reach the age of retirement. A term life insurance policy is often chosen in relation to a specific financial obligation, such as while paying a mortgage.
- Permanent Life Insurance is a life insurance policy that lasts until your death. It has higher premiums but is also an investment because the premium is placed in a separate account that gains interest tax-free, and cash values build up within the policy that can be accessed during the insured's life. With permanent life insurance, you know that your beneficiaries will receive a financial benefit, whenever in the future that may be.
What Is a Life Insurance Trust?
A life insurance trust is one way to incorporate life insurance in estate planning. It is an irrevocable and nonamendable trust, with the life insurance policy as the asset contained within the trust. Once the policy is placed in the trust, changes cannot be made by the named insured in the policy, now called the trust grantor.
A life insurance trust is used in estate planning to exclude the value of the insurance proceeds from the taxable estate for estate tax purposes; the benefits pass directly to beneficiaries upon the death of the trust grantor without estate tax consequences. In fact, life insurance trust proceeds are often set aside specifically to pay for estate taxes.
Most estates, however, are not subject to federal estate taxes, as only about 1% reach the threshold subject to estate taxes [$5.45 million for deaths in 2016], so, for most people, a life insurance trust is not necessary.
Final Thoughts on Life Insurance and Estate Planning
As you can see, a life insurance policy can be a useful, flexible estate planning tool. Whether you acquire life insurance only for emergency purposes or as part of your overall investment strategy, it can give you great peace of mind that your loved ones will be financially protected in the event of your death.
If you have questions about your estate plan and want to speak to an attorney, LegalZoom can put you in touch with an attorney who can answer your questions. By signing up for the personal legal plan, you'll get affordable access to an attorney.