Good Reasons to Use Life Insurance to Transfer Wealth

By Steven Trend CFP, CLU

Prudential Advisors

Many people focus their attention on growing and protecting their personal wealth.  However, when it comes to planning for the end of life distribution of wealth, the plans we make may have profound consequences to those we care about most. Including life insurance with your estate plan can be an effective strategy. Applications for life insurance coverage requires underwriting to determine cost and eligibility. While life insurance is a financially important component of many estate plans because it provides money, the assistance of a knowledgeable attorney with wills, trusts and business agreements is essential.

Let’s consider why life Insurance could be used to plan for the transfer of wealth.  Advantages include:  

1. Life insurance policies are extremely tax efficient: They accumulate cash value on a tax-deferred basis and the death benefits are typically income tax free. 
2. Leverage dollars: With life insurance, the total premiums paid are almost always less than the death benefit. 
3. Rapid Distribution of Funds: Life insurance is not subject to the probate process and thus can usually be obtained within a week to 10 days from the date a claim is made.
4. The designated beneficiary is the one who receives the funds. A will can be contested, whereas the beneficiary designations of a life insurance policy are honored, difficult to challenge and can help avoid family battles. Beneficiary designations can be easily changed by the owner of the insurance policy during the insured’s lifetime, if desired.
5. Insurance provides clarity to the amount the beneficiary(ies) will receive. While other assets may have an uncertain value at the time of death, the death benefit of insurance policies are clearly communicated. The face amount listed may ultimately be adjusted by policy provisions, cash value, loans, the timing of premium payments, and other adjusting factors.

Here are a few common situations where using life insurance can help address  estate distribution issues.  

Estate Equalization: Often an estate has one large asset such as a business or a piece of real estate. When there is more than one heir, there may be the desire to treat each equally.  However, leaving the large asset to be owned jointly could be problematic. Often, it makes sense that one heir become the owner of the substantial asset and the other heirs(s) share the proceeds of life insurance. 

Business continuation: Businesses, such as partnerships, can have multiple owners. When an owner dies his or her portion of the business becomes part of the deceased owner’s estate.  A surviving owner becomes partners with the heirs of the deceased owner, unless there is a pre-existing buy/sell business agreement funded with life insurance that requires the surviving owner to buy, and the estate to sell, at an agreed upon price. 

IRA’s and life insurance: Legislation currently pending in the Senate as of this writing, will require beneficiaries to completely withdraw inherited IRAs within 10 years and pay the resulting tax liability. The 10-year rule would not apply to some beneficiaries such as surviving spouses, disabled individuals, minors and those who are not more than 10 years younger than the account owner. Since more beneficiaries are likely to inherit a larger up-front tax bill, life insurance can help alleviate some of that cost. The life insurance proceeds can be used to pay for some, or all the tax liability caused by the inherited retirement account. It may now make more sense for the account owner to withdraw more of their retirement assets that they do not otherwise need for retirement purposes and leverage life insurance to provide a legacy to their heirs. In addition to repositioning taxable assets to a tax-free vehicle, life insurance proceeds are generally easy to use to fund a trust.

Income Replacement: Whether the insured is a high-income producer, has a pension or just social security, life insurance can help provide financial security in the event of death.

Estate Taxes: People with estates valued in the millions may have to pay substantial estate taxes. Planning with the use of an irrevocable life insurance trust allows the proceeds of the insurance to be paid outside of the taxable estate. The insurance proceeds can be used to offset estate taxes and transfer wealth either directly or with almost unlimited control with the use of trusts. It is important to consider that there may be federal and/or state gift tax consequences with the funding of a trust and the gifts necessary to pay the premiums may reduce the size of the estate and/or the amount of lifetime gift tax exemption and/or estate tax exemption.

Since no two estates are the same, and there can be complexities to any well written estate plan it is best to work with professionals who specialize in estate planning.  Engaging the service of a competent life underwriter is a critical component of the estate planning process because the selection of the most appropriate product in an estate planning case will optimize the transfer of wealth. Life insurance can help provide cash, structure and greater control to every estate plan.

This is general information and is not intended to provide tax advice.  You should consult your tax advisor regarding your personal situation.