Grieving loved ones should not have to inherit assets only to learn that they can't access them as cash to cover expenses for which they are responsible after you pass away. Most retirees’ assets are in homeownership and retirement accounts, requiring a sale to get cash.
Life insurance can play a few key roles in an estate plan, depending on your age and situation in life. It can provide the liquidity needed when managing and distributing your estate assets. Depending on your circumstances and the number of assets at hand, your policies can address the following:
- final expenses
- estate taxes
- business ownership
- probate
- and other purposes.
What Types of Life Insurance Are There?
There are two main types of life insurance: term and permanent.
Term life insurance is the simplest. You buy a policy for a set number of years and have coverage with a death benefit if you die during that period.
Permanent life insurance policies provide coverage for life (or for as long as you pay premiums). In addition to paying a death benefit, the policy builds a cash value, which can be used as collateral for a loan or withdrawn from the account. Whole life, universal life, variable life, and variable universal life are different types of permanent insurance.
Common Reasons for Purchasing Life Insurance
Provide for Your Loved Ones
When children are young, life insurance can provide funds to a surviving spouse and children to help make up for lost income and pay for schooling. Typically, a term life insurance policy will work well for this purpose.
Once you retire, you may no longer need life insurance. If your spouse or other dependents won't lose any income when you die, life insurance may not be necessary. Your premiums may therefore be better spent on other things.
However, more and more people are carrying debt into retirement. In this case, a life insurance policy can be used to pay off that debt once you die. This may allow your heirs to keep a house that might otherwise have to sell to pay off debt. They may also use life insurance to pay off an outstanding mortgage.
Help Cover Final Expenses
The average funeral cost in the US is about $8,000 and somewhat less with cremation. The price becomes even greater when adding a burial plot, vault, or headstone. Even without a funeral service, cremation ranges between $1,000 and $10,000. Depending on the location, the average cost is of around $4,000.
Some debts of the decedent will become part of the estate’s responsibility. These debts can reduce the remaining assets for your heirs, requiring a cash payout. Creditors may present the estate with outstanding bills and even litigate for payment.
State and federal final income taxes are a requirement. The government will seek payment of any back taxes in addition to those taxes owed in the year in which you die. Life insurance death benefits can help address these final expenses, helping meet the estate’s obligations.
Pay Estate Taxes
The size of the estate affects the state and federal inheritance taxes that may be due; how much and at what rate can often be a shifting target. As thresholds change, so too should efficient tax planning for your legacy.
Beneficiaries receive life insurance death benefits tax-free. With the right guidance, these proceeds can be used to offset inheritance taxes and avoid selling estate assets to cover tax obligations.
Transfer Business Ownership
If you own a business or are a co-owner, your passing may present substantial challenges for continuing the business, affecting family or business partners. Many start-ups and partnerships establish plans to address these eventualities, often in a buy-sell agreement. This contract outlines how a departing partner or founder’s business shares will be reassigned to other stakeholders or sold. Life insurance is often the financial product employed to fund such an agreement.
Help Equalize Inheritance
In the case of multiple heirs, assets often do not divide up easily or equally. For example, a vacation home worth $600,000 may be local and desirable to one heir, while the other two heirs live far away and have no interest in the property. To compensate those heirs who do not want to co-own the property, the heir wishing to retain the property must cash them out $200,000 each. This situation can quickly create a family rift.
As part of an estate plan, life insurance can fill the gap and equalize inheritance among heirs. In this case, one heir would get the property outright, while the other two would receive death benefit proceeds to compensate for their portion of the property value.
Avoid Probate Court
Probate court oversees the settlement and distribution of a decedent’s assets. It can be a lengthy, involved, and expensive process even when a general estate plan and will are in place. Life insurance proceeds bypass probate when going to the named beneficiary.
Unlike a public probate process, the payment remains private and tax-free to the beneficiary. Be aware that life insurance death benefits may still be subject to estate tax if the insured had “incidents of ownership” when they died.
Special Purposes: Child Support, Divorce, and More
A life insurance policy earmarked for special purposes can address divorce obligations like child or spousal support. Death benefit proceeds may go toward continued support for a loved one, such as a minor child with a disability or an aging family member.
Mainly these types of direct purpose policies are part of an established trust. Assets like life insurance policies are held in the trust on behalf of a beneficiary and under the supervision of a trustee to meet obligations providing long-range monetary support in a substantially funded trust.
Work with a qualified attorney to identify which trust type will suit your needs. Personal circumstances and goals help define which trust will work best regarding probate, taxes, and more.
Using Life Insurance to Offset Long-Term Care Costs
It may be better to have a permanent life policy in retirement because the cash value can be used to provide income to retirees or to pay long-term care costs. There are also hybrid long-term care insurance and life insurance products that can be used for this purpose.
Consult With an Estate Planning Professional
To make sure you use life insurance effectively as part of your estate plan, find an estate planning attorney near you.