The Role of Life Insurance in Estate Planning

Life Insurance

Do you know the importance of life insurance when it comes to estate planning? The founders of The Financial Awareness Foundation worked with Congress in 2008 to proclaim the 3rd week in October every year as National Estate Planning Awareness Week. Many Americans are unaware that the lack of estate planning may cause their assets to be disposed of to unintended parties due to probate. Let’s discuss the role of life insurance in estate planning.

One of the most common reasons to do estate planning is to spare your family members and heirs the chaos and conflict that often occurs after your death. Another common reason to do estate planning is to protect your children from mismanaging their inheritance, or to shield your children's inheritance from creditors. Your net estate includes your assets minus your debts. Life insurance policies in which you maintain any “incidents of ownership” are includable in your taxable estate. This includes policies you can borrow against, assign or cancel, or for which you can revoke an assignment, or can name or change the beneficiary. Improper ownership of life insurance can increase the size of your estate and the amount of estate taxes that must be paid.

An irrevocable life insurance trust gives you control over your insurance policies and the money that is paid from them. It also lets you reduce or even eliminate estate taxes, so more of your estate can be passed along to your heirs. The trust owns the insurance policies for you and removes them from being included in your estate, which could reduce estate taxes, if they exist. An insurance trust has three components: 1) the insured or grantor is the person creating the trust, 2) the trustee is the person the grantor names to manage the trust, and 3) the trust beneficiaries who will receive trust assets after the insured dies.

The trustee purchases a life insurance policy, with you as the insured, and the trust as owner and (usually) beneficiary. When the insurance benefit is paid after your death, the trustee will collect the funds, make them available to pay estate taxes and/or other expenses (including debts, legal fees, probate costs, and income taxes that may be due on IRAs and other retirement benefits), and then distribute them to the trust beneficiaries as you have instructed.

Who pays the life insurance premiums? The grantor of the trust can make annual tax-free gifts of up to $13,000 to each beneficiary of the trust. If married, a spouse can also gift $13,000 annually to each beneficiary of the trust totaling an annual gift of $26,000. The grantor makes the gift to the trustee who, in turn, notifies the beneficiaries of the gifts. Unless the beneficiaries want the gifts at the time, the trustee may use the gifts to pay the life insurance premiums for the irrevocable life insurance trust to fulfill the role of life insurance in estate planning.

About the author:  Ken Buccico holds a LUTC designation and has been in the life insurance business for 39 years. His wealth of experience empowers clients to make best possible decision regarding a life insurance policy. To explore the best life insurance option, contact Ken at 1-800-651-1953 or KBuccico@Pivot.com.