Three Ways to Incorporate Life Insurance in Estate Planning

Three Ways to Incorporate Life Insurance in Estate Planning

Life insurance is a great way to ensure your loved ones have enough resources to live a fruitful life after you pass away. Not only can life insurance assist with immediate financial needs, but it can also be utilized as a valuable estate planning tool. Here are a few ways life insurance can help conserve and protect your estate.

1.) Use an Irrevocable Life Insurance Trust (ILIT) to Minimize Taxes

If an estate exceeds a certain value, the tax consequence can be as high as 40% federally and 20% at the state level. That can create a hefty tax burden and decrease the size of the inheritance your beneficiaries will receive upon your death.

To leave life insurance proceeds to your estate while avoiding substantial tax consequences, we can use what’s called an Irrevocable Life Insurance Trust (ILIT). An ILIT controls the life insurance policy while the insured is still alive, and it determines how life proceeds are paid out upon the insured’s death. The death proceeds are not taxable as income as well. And if the life insurance policy is owned by an ILIT, the proceeds from the death benefit are not considered part of the insured’s gross estate, and therefore are not subject to state and federal estate taxation. Essentially, the ILIT can maximize the death benefit and make sure beneficiaries receive those funds tax-free.

Oftentimes, second-to-die policies are used to maximize the death benefit paid to an estate’s beneficiaries, as benefits are not paid to the trust until the second policy holder dies. The ILIT structure is an important one for beneficiaries who will be put under pressure to pay estate taxes on their inheritance while holding illiquid assets, like real estate. The death proceeds received may prevent them from a forced sale or from selling in the wrong market for a significantly discounted price.

2.) ILITs can Maintain Government Benefits and Offer Protection from Creditors

Life insurance proceeds owned by a ILIT can also help protect the benefits of a beneficiary who may be receiving government aid, such as Medicaid or social security disability income. The trustee of the ILIT can control how the proceeds are distributed to the beneficiary in order to ensure that the beneficiary continues to receive governmental aid as well as their portion of the death benefit.

For example, if a beneficiary is on the Supplemental Security Income (SSI) program, there are strict asset limitations since it is a needs-based program. If that beneficiary were to receive a life insurance payout, it’s likely that those assets will make them ineligible for continued SSI payments. However, you can set strict parameters regarding the timing of your life insurance payouts to ensure that the beneficiary (for instance, a disabled or special needs child) remains eligible for government aid.

Creditors can also create problems for the beneficiaries of a life insurance policy. If the established beneficiaries do have creditors, they can go after the life insurance proceeds to pay off certain debts. Yet, if the life insurance policy is placed in a ILIT in your estate, creditors are unable to go after those funds and the beneficiary will receive them in their entirety. 

3.) Life Insurance can Ease the Burden of Divvying Up an Estate

Determining who receives your assets, when they will receive them and how they will be paid out upon your death can be quite complex without proper planning. Putting your life insurance policy in an estate can make the process of dividing up assets and paying out proceeds among multiple beneficiaries much simpler as you’re able to prepare for these issues while you’re still alive.

For example, if there is a piece of real estate to which three separate beneficiaries have equal claim, but about which the beneficiaries are unable to come to an agreement, life insurance in the estate plan can help even out that inheritance. One beneficiary may opt to take the piece of real estate, while the other two agree to split the life insurance proceeds, providing flexibility among the heirs to the estate.

Similarly, if you are wary that one of your beneficiaries may use up their portion of the life insurance proceeds immediately, you can annuitize the life insurance payout so that they receive stable income for a select number of years. This is done by putting the life insurance policy in the ILIT and deciding how you would like the proceeds to be paid out while you are still alive.

This article is intended to present you with benefits of estate planning with life insurance. There are many factors to consider when deciding whether this strategy is advantageous for you. As with any financial strategy, please do your own due diligence and talk with your estate attorney and advisor or CPA to determine whether this is best for you.

About the Author

Kieran Lynch

Kieran Lynch

I got my first taste of financial planning during an internship with a wealth management firm during college and learned firsthand about the differences an advisor can make in other people’s lives.  I graduated in 2020 from Saint Joseph’s University in Philadelphia with a degree in Finance and Economics. When I am not at work or spending time with family, I am an avid golfer, a sport that I was fortunate to pick up at a young age thanks to my father. I love being able to enjoy the outdoors and walk the course with some of my favorite people. I am also a sports fanatic, actively looking to find the closest pick-up basketball game in town. While I may live in Boston now, I am a life-long New York sports fan, cheering on the Knicks and Giants. I also love to travel and explore new places, trying new restaurants or venturing into local parks and museums.

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