Life Insurance Within in An Estate Plan
Depending on your needs and goals, life insurance can be an effective tool in estate planning. Not only can a policy provide liquidity for beneficiaries while the estate is settled; proceeds can also cover tax liabilities the base estate may face. If your estate includes items such as business interests, real estate, property, and collectibles, it may take significant time for your estate to have enough liquidity to cover taxes and liabilities.
Death benefit proceeds can be used in the case where a beneficiary wants an illiquid asset and another doesn’t. For example, let’s say you have farmland and one of your adult children has a special attachment to the farm and the other lives in the city. A policy equal to the value of the property and land can be implemented so that both children are treated equally.
For individuals whose estates don’t have a tax liability, life insurance can still be a valuable tool, as a death benefit can be used to replace income, cover final expenses, and address lingering debts.
Life insurance is often used as the funding vehicle for structures like trusts.
Life Insurance Trusts
An irrevocable life insurance trust (ILIT) is an estate planning structure that provides a source of income to a beneficiary, per terms you establish at its creation.
There are three parts to an Irrevocable Life Insurance Trust:
- The grantor – the person or persons creating the trust (you)
- The trustee – the person or entity who manages the trust and administers distributions
- The beneficiaries – the recipients of proceeds from the trust
Generally, an ILIT is structured to where the trust purchases an insurance policy on you and they delegated as both owner and beneficiary of the death proceeds. In the event of your death, the trustee administers proceed distributions to heirs, per your stipulation.
Provided they follow certain arrangements, insurance trusts generally allow for tax benefits, avoiding estate tax consideration.
Estate Tax Issues for Illiquid Assets
Illiquid assets—such as real estate, property, partnerships, and businesses—can present a challenge when settling an estate. Because these assets are not easily converted into their cash value or lose value in this process, they can make transferring wealth and dealing with estate taxes difficult.
The main challenge illiquid assets present to an estate’s tax consideration is that they take time to convert to a liquid asset. If the estate is subject to federal estate tax and the bulk of the estate in property or business interests, the burden will be on the executor and beneficiaries to settle the tax bill, since the overall value of the estate exceeds liquid assets. Life insurance is a commonly used tool to provide liquidity in order to allow sufficient time to monetize illiquid assets.
Keep in mind this is a general survey of the estate tax issues on illiquid assets. What will be effective for your estate will depend on your situation and estate planning goals.
Charitable Gifting of Life Insurance
Along with transferring wealth to beneficiaries—like a spouse, child, or other family members—you may want to consider charitable giving. At its simplest, charitable giving involves appropriating a portion of your accumulated wealth to an organization or a cause that matters to you. This is a great way to support the cause or causes that you value, while leaving a lasting financial legacy that often keeps these organizations or causes viable.
Charitable giving is not only a way to fulfill your philanthropic desires. It can be used as a planning tool and provide you with benefits such as tax deductions, avoidance of capital gains and highly appreciate assets, and minimizing (or eliminating) estate taxes upon your death. There are even certain charitable giving strategies and solutions that allow an income stream accessible during life. With an increasing tax environment expected in the U.S. in the coming years, there may be many compelling reasons to incorporate philanthropy into your financial and estate planning.
Although the basic idea behind charitable giving strategies is simple, the mechanics and structuring may not be. This is where having an expert and experienced financial advisor comes in play.
There are numerous ways a life insurance policy can be used to extend a member’s sustaining gift. The bottom line is that charitable gifting of life insurance can be beneficial for both the selected organization/cause and the donor.
