Life Insurance in estate planning is a common tool as it provides liquidity in an estate.

Life Insurance in Estate Planning for Estate Equalization

That liquidity can be used to pay estate taxes or to equalize an estate. By equalize, we mean to make sure that each beneficiary gets the same amount, say in the case of children.

Let's say Mr. Smith has two sons. Son 1 works with him in the business and wants to take over the business when dad passes. The business is worth $5 million. Mr. Smith will leave the business to Son 1. Son 2 has no interest in the business. So how can Mr. Smith treat his sons equally in his estate plan?

The answer is to use life insurance in estate planning. Mr. Smith purchases a life insurance policy payable to Son 2 for $5 million. Each son then inherits an asset worth $5 million in this simplified example.

But what if Mr. Smith has a heart condition and he cannot get life insurance; he is uninsurable. He can still use life insurance in estate planning.

One answer is to obtain a joint policy with Mrs. Smith. Often called survivorship policies or second-to-die policies, these policies insure two people. But the insurance company bases the issuance of the policy on the healthier of the two parties.

So even if Mr. Smith is uninsurable due to medical conditions while Mrs. Smith is in fair to excellent health, the insurance company will place their "bet" on Mrs. Smith as the policy pays off when the second of the two insured parties die. And since Mrs. Smith looks sure to outlive her husband, the insurance company is really taking their risk on Mrs. Smith.

What if Mr. AND Mrs. Smith are both in poor health and uninsurable. There is still an opportunity to use life insurance in estate planning.

Does Mr. or Mrs. Smith have any siblings about their same age? If so, are these people insurable? If these siblings are amenable, they can have the insurance placed on their life payable to Smith Son 2.

The reason this makes sense is that Mr. Smith's objective is that each son gets the same amount of assets "around" the time of his death. If Mr. Smith is 70 and he has a brother is 72, they have similar life expectancies. If the insurance is placed on the brother, Son 2 will receive the $5 million at the death of his uncle (rather than at the death of his uninsurable father). But Mr. Smith’s objective is attained this way.

The point here is not to get hung up on the health or insurability of a specific person. Look to see if there are other relatives of the same age group that is insurable to pursue an estate planning objective.

Also be aware that insuring the uncle may bring up an "insurable interest" question by the insurance company. A person has an "insurable interest" in something when loss or damage to it would cause that person to suffer a financial loss or certain other kinds of losses. For purposes of life insurance, everyone is considered to have an insurable interest in their own lives as well as the lives of their spouses and dependents.

But Son 2 does not have an obvious insurable interest in the life of his uncle. However, if the facts are presented to the insurance company and the family's overall objective to equalize an estate for the next generation, the insurance company will likely accept this arrangement.

Life Insurance In Estate Planning for Estate Liquidity

At your death, estate taxes need to be paid (if you owe estate taxes). Currently, in 2018, it is not likely you will owe estate taxes and only those with estates over $5.6 million do.  However, Congress changes this threshold every few years so you could owe estate taxes in the future.

Additionally, your State may levy an inheritance tax on your beneficiaries. Where will beneficiaries get the cash to pay the tax?

If you are married and you pass, any estate taxes may be delayed until your spouse's death. Other costs such as funeral expenses, debt settlement, and administration fees can add to the need to have immediate cash at death and life will insurance provide that liquidity. Other than cash on hand, no asset can provide such a predictable and immediate influx of dollars to pay the costs incurred or supply the liquidity needs as can life insurance.

Perhaps, to pay estate taxes, liquidation of your investments or business may not be timely and produce a substantial loss in value. To maintain intact your investment holdings or business so you can pass them on to your children, you or your spouse may purchase life insurance as, possibly, a more economical option to having to liquidate your holdings.  Why sell assets when a simpler supply of cash can be available?

If you are married, survivorship life insurance generally is used to provide liquidity for final expenses when the second one of you dies.

Life Insurance In Estate Planning for Charitable Bequests

You can combine charitable giving with life insurance to make the donations you always wanted to and you can do this without reducing assets you want to pass on to your beneficiaries.

Here is how it works…
You can - if you have the wealth - give a substantial lifetime gift of appreciated property to a qualified charity. This gifting generates a significant tax deduction. With the income tax savings, you get from this deduction, you can purchase life insurance - whose proceeds at your death will replace the wealth that you gave to charity.  That is, the life insurance proceeds will go to your children (tax-free)

Policy Owned Outside Your Estate

In both these examples, if you maintain ownership of the life insurance, then its death proceeds will be added to the value of your estate. This, in turn, will add to the estate tax on your estate. The simple solution is to have the policy owned by family members.

The fact that life insurance proceeds are free of income tax does not alleviate its contribution to your estate tax. You can keep the life insurance that is on you out of your estate by either giving away ownership of it - at least three years before your death - or by having some other person or legal entity purchase it and own it in the first place. In that case, the insurance proceeds may still be used for paying all those final expenses but would not add to your estate tax. Trusts are common legal entities for purchasing and owning life insurance in such circumstance.

For any beneficial use of life insurance in your estate,  an agent experienced with life insurance in estate planning can help.

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