One of the goals of estate planning is to leave assets to your heirs in the most efficient manner. Life insurance can play an important role in your estate plan. Life insurance proceeds can provide a ready source of cash to pay estate taxes, so that beneficiaries will not be forced to sell an asset, such as a business or home, at an inappropriate time.

In this section you will learn about:

  • Using life insurance to help maximize wealth transfer
  • Making practical ownership decisions
  • The irrevocable life insurance trust (ILIT)
  • The different types of life insurance
Life insurance can be used to provide income-tax-free benefits to spouses, partners, or other beneficiaries. This insurance:
  • Avoids the expense and delays of probate at death, as the proceeds are paid to your designated beneficiaries. (This may benefit a spouse or partner who is handling final expenses, raising children, or has other expenses, such as a mortgage.)
  • Provides a way to accumulate capital that has the potential to grow income tax free.
  • Provides death benefits that will not be subject to income or capital gain tax.
  • Offers liquidity needed for a surviving owner to buy your business via a buy-sell agreement. (With a buy-sell agreement, you can provide for an orderly transfer, allowing employees and co-owners to retain their positions in the company.)
  • Replaces estate taxes or income taxes that your partner or other beneficiaries may owe at your death on retirement assets (such as IRA assets, annuities, or other assets).
  • Gives you the opportunity to leave a charitable bequest to your favorite charities upon death, provided the charities are the named beneficiaries.

These are just a few of the solutions life insurance offers. After evaluating your situation, you may want to consider purchasing or maintaining life insurance to meet your financial and/or estate planning goals. Your attorney can verify state rules on insurable interest to ensure life insurance is an appropriate planning option for you and your spouse or unmarried partner.

The ownership of your life insurance policy is an important estate planning consideration. Although life insurance proceeds pass free of income tax to beneficiaries, the proceeds are not necessarily free of estate taxes. If you, the insured, own the policy, the proceeds are part of your taxable estate and are potentially subject to estate tax. Your policy may also be included if you had made arrangements to transfer it from your estate within three years of your death.

If you want to remove life insurance proceeds from your taxable estate, you cannot own the policy. Who can own it?

  • Your personal situation probably dictates the best type of ownership for life insurance.
  • Your spouse or partner could own the policy. (If you have adult children, they could also own the policy, but dividing ownership among multiple children could be cumbersome.)
  • If you would like to provide for a convenient way to have a single owner manage the policy and want to protect the policy from your beneficiary‚Äôs potential creditors, an irrevocable life insurance trust may provide a solution.

An irrevocable life insurance trust is simply a trust that owns the policy on behalf of your beneficiaries. When you die, the trust receives the life insurance proceeds, and no estate taxes are due on the proceeds. The trustee will then manage (and eventually distribute) the trust assets according to the instructions you left in your document.

This strategy can be very useful for same-sex couples who simply choose not to be married. Even if assets left to a partner would be subject to estate tax, an irrevocable life insurance trust can be created to provide nontaxable assets for the surviving partner.

Usually you will use annual exclusion gifts to fund the trust, which will enable the trustee to acquire the life insurance policy.

Each year, your trustee must notify each beneficiary that, for a period of time, he or she has a right to withdraw that year's trust contributions within a specific time. This is necessary for the gift to qualify for the annual exclusion. Because the trustee can use your annual gifts to pay the insurance premiums only if your beneficiaries leave the annual gift in the trust, your partner and/or children will need to understand the consequences of taking the funds.

For this reason, you may want to explain the purpose of your irrevocable life insurance trust in a family meeting so your beneficiaries understand what's required for the trust to work. Your tax advisors, legal advisors, and Financial Advisor can help you arrange this meeting.

There are several types of coverage that may fit into your overall financial portfolio.

Term life insurance provides a death benefit for a limited time frame.

Permanent insurance provides an opportunity for cash value in the policy to grow tax deferred, in addition to a death benefit.

Survivorship life insurance insures the lives of two individuals under one policy, with the proceeds payable to the beneficiaries upon the survivor's death. This type of policy might be used by a couple whose goal is to transfer wealth to a child or children upon the second spouse's or partner's death to provide for their support.

Your Financial Advisor can help you structure a suitable policy to help meet your needs and objectives.