Life Insurance and Estate Planning
The loss of a loved one is devastating. Adding to the stress and pain, financial burdens can accumulate quickly, from funeral expenses and medical bills to loss of income. Life insurance policies are designed to offset this burden by providing both short-term alleviation and long-term financial security. Unfortunately, many Americans do not fully understand the importance of life insurance and the role it plays in effective estate planning.
Providing Security for Your Loved Ones
According to the National Funeral Directors Association, the average cost of a funeral is $7,045. However, this is only a small fraction of the debt you may leave behind. Credit card debt, medical expenses, even income taxes can weigh on an estate and your loved ones—especially during the months immediately following your passing. Life insurance policies provide immediate liquidity to pay debts and provide help in transferring wealth from one generation to the next.
The liquidity that life insurance supplies can also be used to pay estate taxes that might otherwise have to be settled by selling a portion of the estate. This is especially crucial for affluent Americans, those with an estate worth more than $5,430,000 (per individual), whose estates are taxed at 40% above this limit. The liquidity provided by a life insurance policy can offset the cost of any federal estate taxes or separate state inheritance or estate taxes.
For many small-business owners, life insurance provides a protection for their business and a means to facilitate a succession plan. Your business is likely a large component of your estate. As a leader and contributor to that business, your absence will leave a void, perhaps threatening the viability of the business. For a company with significant cash flow needs, life insurance can provide liquidity to cover short-term expenses.
The liquidity provided by a life insurance policy essentially buys time and flexibility to make smarter financial decisions.
Permanent Versus Term Life Insurance
Once you have decided to purchase life insurance, you will have to choose between permanent and term coverage. Term insurance generally provides a pool of money if something happens to you for a limited period of time. It is the more popular option in the United States, especially for younger people. However, it doesn’t offer as many options for those looking to transfer wealth. Term policies cover only a particular time frame, and many companies will not offer term policies that go beyond a certain age, typically a few years after the average person retires.
Permanent life insurances provides lifetime coverage. It typically comes in two forms, whole life and universal life. Whole life offers consistent premiums and cash value accumulation, while universal life insurance offers some flexibility in premiums and possibly a savings option. Universal life insurance, sometimes known as adjustable life insurance, allows policyholders to reduce or increase the premium and benefits after making their first payment. Many who are purchasing a life insurance policy later in life choose universal life insurance because it allows them to increase their payments, essentially making up for years they were not contributing.
What Is Right for Your Business or Family?
There is no perfect life insurance plan that meets all possible needs, so it is important to sit down one on one with your financial advisor to identify your specific needs. To get started, consider the following questions and concerns to see if you have fully incorporated your life insurance strategy into your estate planning:
- Is my life insurance policy a part of my living trust?
- If not, what kind of trust should I use—revocable or irrevocable?
- Can I use life insurance to set up a charitable giving plan?
- Can I name a charity as a beneficiary?
- How do ownership and beneficiary designations affect my taxable estate?
Taking the time to answer questions like these and incorporating life insurance as part of your estate planning can help protect your business and loved ones when you are gone, and may offer a more effective method of transferring wealth to your beneficiaries.