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Estate Planning with Life Insurance

| April 24, 2023

Life insurance can be an effective tool for estate planning. It can help to provide for your loved ones after you pass away and ensure that they are taken care of financially.

One of the main benefits of using life insurance for estate planning is that it can provide liquidity. This means that it can provide cash that can be used to pay estate taxes, settle debts, and cover any other expenses that may arise after you pass away. This can help to ensure that your assets are not depleted when passed through your estate.

Estate Tax

When a person passes away, their estate, depending on its size, may be subject to federal and/or state estate taxes. This can be a significant expense, and if the estate does not have sufficient liquid assets to pay the taxes, it may be necessary to sell assets, such as real estate or investments, to generate cash. The death benefit paid out by a life insurance policy is generally income tax-free and can be used to pay any estate taxes owed. The liquidity provided by life insurance can be especially useful if the estate's assets are illiquid, such as a family business or real estate.

Equalizing Inheritances

Another benefit of using life insurance for estate planning is that it can be used to equalize inheritances among your beneficiaries. For example, if you have one child who will inherit a business or real estate and another child who will not, you may want to use life insurance to provide a financial benefit to the child who will not inherit the business. This can be particularly useful if the estate is subject to estate taxes, as it can help to ensure that each beneficiary receives a fair share of the estate's assets, regardless of the estate tax implications. Life insurance proceeds typically pass outside of the probate process, which can be lengthy and expensive. This means that your beneficiaries can receive their inheritance without having to wait for the probate process to be completed.

Using an Irrevocable Life Insurance Trust (ILIT)

Life insurance proceeds are included in the taxable estate if the policy is owned by the insured at the time of their death. However, there are ways to structure life insurance policies to avoid estate taxes, such as setting up an irrevocable life insurance trust (ILIT) or transferring ownership of the policy to someone else. The irrevocable life insurance trust (ILIT) can be an important estate strategy tool that may accomplish several estate objectives; however, it may not be appropriate for every individual.

An ILIT is created by an individual (the grantor) during his or her lifetime. The ILIT owns a life insurance policy on the grantor’s life via the transfer of ownership of an existing policy or through the grantor’s annual contribution of cash to pay the premiums on a policy purchased by the trust.

The grantor designates beneficiaries, usually family members, who will typically receive the proceeds upon the death of the grantor. The trust is irrevocable, meaning that the grantor forfeits all rights to the property contained in the trust. Its irrevocable nature is integral to accomplishing the ILIT’s objectives.

When you die, the trust is designed to receive a payment equal to the policy coverage amount. Since the trust’s ownership of the policy is irrevocable, the proceeds are not considered your property. Consequently, they do not fall into your estate, thus potentially avoiding estate taxation. (Remember, generally no income tax is due on such life insurance proceeds.)

The trust provisions should be set up to provide direction on how and to whom payments may be made. You may direct that the trust pay out cash to cover certain expenses, e.g., funeral costs, probate, taxes, final medical expenses, and debts. This may obviate the need to sell less liquid assets at an inopportune time to cover such costs.

The trust’s beneficiaries may receive the proceeds (after any payments are made to satisfy liquidity needs), creating an inheritance free of estate taxes. Additionally, creditors should not be able to attack these assets since they belong to the trust, not you.

It is important to work with an experienced estate planning attorney and financial planner to determine the best strategy for your specific situation.

Estate Planning with RMR Wealth Builders

Having a detailed estate plan in place ensures that, when the time comes, transferring your estate to your beneficiaries is a smooth and stress-free transition. Working with an estate planning attorney is helpful for several of the specific legal aspects involved in estate planning. A financial planner helps you create estate planning strategies that address your goals and the concerns that you have in mind.

RMR Wealth Builders leverages eMoney’s cutting edge technology to meet the financial and estate planning needs of our clients. For estate planning basics, eMoney provides a digital vault that helps you to organize the documents included in your estate plan. For more advanced estate planning needs, our financial planners utilize eMoney Estate Mapping to provide a visual representation of how your assets will pass and to whom. The Decision Center™ allows you to see how changing scenarios and strategies impact your overall estate plan.

Reach out to your financial advisor to set up a meeting with our financial planning team and get a clear picture of your overall estate plan.