Life insurance protects families against financial expenses in the event a parent or spouse passes away. It is also a valuable estate-planning tool for people who leave much wealth to their heirs. Including life insurance in your estate plan provides your heirs with flexibility in the future. Inheriting a lot of wealth comes with challenges, but the right life insurance guarantees that your heirs will overcome the obstacles without breaking up the estate.
Life insurance can provide immediate funds for survivors. Heirs are often responsible for sorting out the deceased’s assets and liabilities while they are grieving. But life insurance can ease the burden by providing financial assistance to grieving family members.
Life insurance is divided into two major categories, universal or whole life insurance and term life insurance. Though both types are useful in various ways in estate planning, consulting with estate planning services is essential. You should also assess your life insurance as business, estate, and family needs change over time. Life insurance brokers can help you determine the best one for your needs.
Term life insurance covers a fixed period, generally from 10 to 30 years. It is best for those with finite insurance needs, like providing for minors until they become adults. The fixed term makes it affordable, especially for younger individuals. On the other hand, permanent life insurance offers lifetime coverage, hence ideal for estate planning purposes. However, it is costly, and you should purchase it if your estate is complex or extensive.
But should an estate plan include life insurance? Life insurance may not seem to affect how you will dispose of your wealth. However, it is a vital component of a carefully thought-out estate plan. Life insurance proceeds can do more than provide an enormous sum to your heirs. Here are a few reasons why estate planning should include life insurance.
Estate Taxes Payment
A life insurance policy is one of the best ways to settle estate taxes. The federal estate tax must be paid within nine months after the owner’s death and applies to the deceased’s gross estate. In addition to federal estate taxes, some states impose state estate taxes. However, the proceeds of life insurance are tax-free.
Estates worth above 24.12 million US dollars for couples and 12.06 million US dollars for individuals are taxed at a rate of up to 40 percent. The tax amount, combined with a short nine-month time frame to pay the tax, can stress a grieving family, especially if they inherit an estate with insignificant illiquid assets. A life insurance policy can offset the assets and save the family from having to sell assets in haste and probably below the market price.
Failure to pay federal estate taxes can lead to dire consequences. The executor can be personally liable. If they had transferred the assets to the heirs, the Internal Revenue Service (IRS) could seek to recover the estate taxes from the transferred assets. Failure to pay taxes can create crucial problems for every person involved in the estate. However, the proceeds of life insurance can provide the needed funds to pay all federal and state taxes and prevent problems with the IRS.
An estate can gain or lose value depending on state and federal taxes. These taxes are due nine months after the owner’s death, and liquidating the deceased’s assets may take time. Furthermore, investments, loans, savings, and liquidation may be insufficient to clear the outstanding balance. Estate tax payment is one of the best answers to “why should an estate plan include life insurance?” Life insurance can be one of the best ways of alleviating the estate tax financial burden.
You should always check your state’s estate tax exclusion law. While the exclusion law for federal estate tax is 23.4 million US dollars for couples and 11.7 million US dollars for individuals, your state’s exclusion tax may be lower. However, starting January 1, 2026, the proposed federal tax law will return the exemption to 5.49 million US dollars adjusted for inflation. This will be approximately 12 million US dollars for couples and six million US dollars for individuals. Though your asset may be below the taxation threshold, tax changes are inevitable.
Business Asset Coverage
Universal or whole life insurance provides access to investment savings components. Based on the policy’s terms, these components allow you to borrow funds to cushion your businesses in case of problems. Furthermore, life insurance can fund a buy-sell agreement or act as collateral for business loans. To buy the shares of a deceased or leaving partner, surviving partners must follow the terms and prices stipulated in buy-sell contracts. In case of death, the surviving owners receive death benefits, and your heirs receive payment for your share of the company.
Business or farm heirs can purchase life insurance policies for their parents. Such a policy will provide income in the event of their parent’s death for the buyout of operating assets, land, business assets, or machinery from other heirs that don’t intend to keep the farm or business. However, a vital aspect is that the business or farm heirs own the life insurance policy and make all the premium payments.
Business and farming partners may buy life insurance policies for each other. The death benefit proceeds provide funds for purchasing the deceased partner’s assets in case of death. The living partner can keep the farm or business assets intact. Furthermore, the proceeds of a life insurance policy can be used to enhance an estate and provide more revenue to the beneficiaries.
Liquidating the assets of a deceased person can take time. However, family members can claim a life insurance policy’s death benefit immediately and use it to reduce the financial burden by paying for the expenses related to the death. Such costs include burial and funeral costs, taxes, and debts.
Being a breadwinner comes with multiple responsibilities. Your family may be fully dependent on you for their expenses, and your death may result in a complete loss of income. This is a significant reason you should let your estate plan include life insurance. Life insurance replaces lost income and provides access to cash.
The life policy can continue supporting your family through the death benefit. Depending on your policy’s terms, you can choose your policy benefit as an income replacement, pay for emergencies like medical costs, or clear your debt. Furthermore, you can convert the benefit into retirement income by executing a transfer into an annuity or surrendering the cash value. Permanent life insurance policies accumulate cash value with time, and you can use the funds to pay for emergency expenses. Moreover, loans against life insurance policies are tax-free if they are not more than the premiums paid.
Asset Distribution and Estate Equalization
Handling an estate with more than a single heir can be complex, and the challenges of splitting up the assets may lead to conflicts. Furthermore, there are unique cases where splitting an estate may compromise its ability to generate income. In such cases, estate planning lawyers may use the death benefit of an insurance policy to equalize estate inheritance. For example, one heir may receive the insurance policy proceeds while another gets the property.
Though deciding what inheritance to leave for each heir may prevent fallouts and disagreements after death, some assets, like businesses and buildings, may have multiple heirs. An estate planning attorney can use the proceeds of life insurance to balance the value of assets. For instance, one child can take the entire business or building whole another takes the insurance proceeds.
Furthermore, life insurance can help to equalize asset distribution between the heirs using your business. For instance, you can have a buy-sell contract where the business will buy a life insurance policy that will benefit participating heirs in case of your death. However, discussing this with your heirs before finalizing the life insurance policy would be helpful. Determine those that are willing to participate in the business and those that are not. Those not willing to participate in the business can get a cash distribution from the policy.
Passing the proceeds of a life insurance policy to non-participating heirs and business assets to participating heirs allows the business to flow continuously within the family. The non-participating heirs receive an insurance benefit equal to the value of the business assets. This enables every heir to receive their rightful share while preserving the business intact.
The life insurance policyholder may choose how the insurance proceeds will be used. For example, the policy owner may decide that the proceeds be used to support a loved one after death. Such a policy is helpful for minors, children with disabilities, and aging adults. The policy may also continue paying for child support, alimony, or fund a trust for any other purpose. The trust will hold the assets on behalf of a beneficiary under the management of a trustee.
If you want to provide for an heir with special needs, let your estate plan include life insurance. The heir may be unable to provide for themselves, necessitating the need to plan for their future. The plan may involve providing a source of income for them. However, the cost of lifetime care may lessen the inheritance to other heirs.
In such cases, life insurance is the perfect option for providing lifelong financial support to the special-needs heir without affecting the rest of the estate. However, estate lawyers advise exercising caution when leaving assets to an heir with special needs who receives government benefits. These benefits have strict income limits.
A direct inheritance to an heir with special needs can eliminate or reduce their government benefits. However, creating a special needs trust (SNT) can help overcome this challenge by stipulating that the inheritance will cover costs not covered by state or federal benefits. Such expenses could include insurance, qualified education, equipment, and medical expenses. The SNT will preserve the government or state benefits since it does not give the money to the dependent but pays for the expenses directly.
Create an Irrevocable Life Insurance Trust
A significant reason you should let your estate plan include life insurance is to create an irrevocable life insurance trust (ILIT). The trust will control either a permanent or term insurance policy while the policyholder is still alive. Policy owners can transfer their insurance policies to the trust or purchase life insurance through the trust. This simply means the trust owns the life insurance policy and allows the trust document to specify who will administer assets, identify beneficiaries, and determine the terms of how heirs receive benefits.
The most significant benefit of an ILIT is that it can help minimize or eliminate estate tax liabilities on assets that don’t qualify for marital or charitable deductions. It does so by removing the life insurance policy from the estate. The ILIT can also assist with managing and distributing proceeds in case of death and immediately provide liquidity for the beneficiaries.
An ILIT involves three parties, the insured or grantor, the trustee, and the beneficiaries. The grantor is the person the life insurance policy covers and is the one who transfers assets to the trust. They also specify the beneficiaries and can’t terminate or alter the ILIT since it is irrevocable.
The second party, the trustee, is the policy owner who manages and administers the trust. They control the trust until the period and conditions set by the insured/grantor are met. The terms of the ILIT determine the proceeds of the life insurance policy. The final party, the beneficiaries, are the entities or individuals that receive the insurance policy’s benefits after the grantor’s death. A legal guardian or parent will be in charge if the beneficiary is a minor.
Letting your estate plan include life insurance has numerous benefits for you and your heirs. However, you should consult trust estate lawyers, tax experts, and business insurance services. But once you’ve made up your mind, act fast. The younger and healthier the policyholder is, the cheaper the policy.