Life insurance has long been a part of estate planning in the United States. Although life insurance does not need to be a part of every person’s estate plan, it can be incredibly useful, particularly for parents of young children and those who support a spouse or a disabled adult or child. If you have dependents that rely on your earning capacity then having life insurance can help support them in case something happens.
With every estate of a deceased person, there are numerous fees and costs associated with the administration process that can add up pretty quickly, particularly if there are estate or other tax liabilities involved. Life insurance provides funds that can cover these fees and costs. With proper estate planning you can control the terms of the life insurance distribution. You can name your living trust as the beneficiary of the policy or transfer ownership to a separate Irrevocable Life Insurance Trust. The latter technique will provide liquidity as a wealth replacement strategy in the case estate taxes are incurred on the rest of the estate (Irrevocable Life Insurance Trusts typically avoid estate tax).
The estate tax, while currently at $5 million per person and a 35% rate for every dollar above that (couples can protect up to $10 million), expires at the end of 2012 and has a good chance of changing again beginning January 1, 2013. We blogged on this topic on July 14, 2011, under “Is My A-B trust Obsolete.“ Also, here are the Rules and the Exemptions for the Estate Tax along with a discussion on the future of the estate tax and what it might be like come 2013 and beyond. In advanced planning cases, estate tax reduction usually revolves around three major approaches: gifting through the use of discounting, life insurance, or charitable devices. Any of these methods are highly technical and beyond the scope of this article.
There are also several types of policies that can cover long term health care costs and can begin paying for themselves if funded appropriately. Another benefit of life insurance, in addition to being income tax free (remember it could still trigger estate tax liabilities), is that when a policy is distributed it avoids probate. Avoiding probate can be life saving as if other assets are tied up having to go through the probate court process the policy can provide immediate cash for your beneficiaries.
You should always confer with your estate planning attorney regarding what your estate planning goals are so you can determine together if life insurance is a good planning tool for your family.