Uses of Permanent Life Insurance in Estate Planning
Uses of Permanent Life Insurance in Estate Planning
An estate is the total sum of all the assets you leave behind after you die. The distribution of these assets is usually pre-determined through a Will. If there is no Will the execution of all assets is usually decided by a court of law. An estate could be as simple as naming a beneficiary for your 401(k) or it may require creating several trusts in order to distribute a vast estate.
Many people are under the mistaken impression that estate planning is required only when you are wealthy. Regardless of how much money you have, calculating the value of all your assets against your liabilities will help you determine exactly how much your family will be impacted financially, if you were to die suddenly. Many people are surprised to learn that the total gross worth of their estate could be liable for federal estate taxation after considering all their assets in addition to the value of their life insurance policies.
Estate Planning Using Life Insurance as a Tool to Protect your Estate
Estate planning makes sure that your heirs/beneficiaries receive your estate in full. If you did not do any estate planning, your children may not be able to afford paying estate taxes. In such a case, they would be forced to liquidate some of your assets in order to pay these taxes, leaving them with a smaller fraction of your estate.
Should I Purchase Permanent or Term Life Insurance?
When you want to use life insurance for estate planning purposes, permanent or whole life insurance is the best way to go. With a term life insurance policy, you run the risk of the policy expiring before you do, leaving your family unprotected at the time of your death, which is when coverage for this purpose is specifically needed. Whole life insurance is life-long and premiums generally paid throughout life or up to the age of 100. Whole life accrues interest which may be used to pay premiums when the policy has matured to a certain level.
How to Use Life Insurance in Estate Planning
A permanent life insurance policy can be used in several ways for estate planning.
Create an estate for your children. Life insurance is typically used to compensate for loss of income when a breadwinner/caretaker dies. Life insurance needs are most critical when you are just beginning your career, you have a young family to support and a high mortgage to pay. Life insurance, at this time, can help create an estate that your dependents can rely on.
Equalize your children's inheritance. If you own a business, it only makes sense that you would want to leave your business to children who are actively involved in the business. In this case, heirs who are not actively involved in your business can be compensated by designating them as the beneficiary of a life insurance policy.
The same holds true for any properties or fixed assets that cannot be broken such as your family home or farm. Your heirs can receive equal shares of all assets. The life insurance proceeds each child receives can then be used to buy out the shares of other family members.
You may have children from a first marriage that you want to include in your estate. In such a case, leaving your estate to your second wife and children born through her would leave nothing for the children born from your first marriage. Children from the first marriage have a right to contest for inheritance. You may avoid fighting and ill disputes after your death by designating the children from your first wise as beneficiaries of your life insurance policy.
Life insurance can be used as an instrument to effectively plan taxation. This is useful when the total value of your estate exceeds the federal tax exclusion. Life insurance proceeds are typically not subject to income tax, but the proceeds can be liable to federal estate taxation. For 2010 and 2011, the taxable estate exemption thresholds for an individual are $5 million (up from $3.5 million in 2009). For married couples, this threshold is $10 million and it applies to both estate and gift-tax levies. The top tax rates for estates above these levels are 35 percent. Estates that are worth $5 million or less will not be liable to federal taxing.
If you own all or part of the policy when you die, the proceeds from death benefits can be included in the gross value of your estate for federal estate tax purposes. State inheritance taxes and federal gift taxes may also be applicable to life insurance proceeds under specific conditions.
Federal law requires that you pay taxes on your estate upon your death. For this reason, estate tax is also sometimes called a death tax! Estate planning involves taking care of your financial portfolio in such a way that you pay the least amount of taxes, if any. A life insurance policy can be used to offset the amount of tax likely to be applicable on your estate.
Build up your estate. You can use life insurance as a means to build your estate providing money for your heirs so that they have a sound financial inheritance.
A valuable tool for estate planning is a survivorship or a "second to die" policy. This type of life insurance policy insures a married couple and pays death benefits only when the last surviving spouse dies. The policy itself is usually owned by a trust or children of legal age in order to keep the proceeds out of the estate. After the death of both partners, a survivorship life insurance policy can help offset federal taxes and replace assets used to pay off any debts. Premiums of a survivorship policy are usually lower, even if one partner has health concerns.
Conclusion
You can make estate planning through life insurance work to your advantage. Life insurance should be a vital component of any estate plan. It can be used to provide income to your beneficiaries, education for your children, pay off debts such as a mortgage, replace wealth lost due to expenses and taxes incurred after your death. You can also use it to make gifts to your favorite charity.
Continue to assess your life insurance every year as family and estate needs change. These changes must be reflected in your life insurance so that you don't wind up paying too much or too little for life insurance.
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