As we regularly discuss on our blog, preparing a comprehensive estate plan is a process that involves considering a number of different options in light of your own unique personal needs and circumstances. While some individuals may be able to plan their entire estates with a revocable living trust, a basic “pour-over” will, and some beneficiary designations, others will frequently need to use a variety of estate planning tools in order to minimize their estate’s tax burden while ensuring that their final wishes are carried through with minimal burdens for their loved ones.
One often-overlooked estate planning tool that can have significant value under a wide variety of circumstances: Life insurance. When used appropriately in conjunction with other estate planning tools, life insurance policies can provide tax-free security for your beneficiaries after your death, while also helping ensure that assets with sentimental value remain within the family.
Types and Benefits of Life Insurance
To begin our discussion, let’s take a look at the types of life insurance that are available. Life insurance is coverage that you buy during your lifetime to help your loved ones meet their financial needs after your death. There are two primary types:
- Term Life Insurance – Provides a set amount of coverage for a period of years, with your beneficiaries receiving payment if you die while the policy remains in effect.
- “Permanent” Life Insurance – Provides coverage for your entire lifetime, typically with premiums that are higher than those for term life insurance, but also with the potential for appreciation in benefits.
Among the benefits of life insurance is that the proceeds paid to your beneficiaries will generally be tax-free. There are certain exceptions, but these can typically be addressed with careful planning.
Life Insurance vs. Long-Term Care Insurance
Long-term care insurance is exactly like it sounds: It provides coverage for long-term care expenses should you incur them in the future. Long-term care insurance policies come with numerous options – almost too many to consider – and predicting what you will need and when you will need it while you are still eligible to purchase coverage (you won’t be able to buy coverage if you are in poor health) presents some obvious challenges.
Recently, long-term care insurance premium has become extremely high with a rising nursing home cost and many families in need are not able to afford it anymore.
Life insurance that provides for long-term care became popular as a better option than a stand-alone long-term care insurance when it comes to protecting your loved one’s financial security – especially when you consider:
- Life insurance premiums are generally lower than long-term care insurance premiums.
- You may never need long-term care, and unused life insurance benefits pass down to beneficiaries instead of being lost with long term care insurance.
- You have more planning options when it comes to maximizing the value of a life insurance policy.
Estate Planning with Life Insurance – Two Primary Options
As we mentioned above, when it comes to incorporating life insurance into your estate plan, you have numerous options available. However, two of the most popular options are: (i) using an irrevocable life insurance trust, and (ii) using as a supplement in a charitable remainder trust.
1. Using an Irrevocable Life Insurance Trust (ILIT)
An irrevocable life insurance trust (ILIT) is a special type of trust that is specifically designed to maximize the financial benefits of purchasing life insurance. In order to use an irrevocable life insurance trust, you must first establish the trust, and then you purchase a life insurance policy (or transfer an existing policy) which becomes an asset of the ILIT. Since the policy is held by the trust, it is not part of your estate, and this means:
- The overall size of your estate (and therefore your potential estate tax liability) is significantly reduced.
- Since your estate tax bill will be lower, you will not need to purchase as much coverage for your beneficiaries.
- The cash value of the policy will be better protected from your creditors should you incur a substantial liability during your lifetime.
Since an irrevocable life insurance trust is, by its nature, irrevocable, it is important to thoroughly consider your options and the requirements for establishing an ILIT before you move forward with including an ILIT in your estate plan. But, under the right circumstances, a carefully planned ILIT can have tremendous value as both an estate planning tool and an asset protection strategy.
2. Using a Charitable Remainder Trust with Life Insurance
Another popular option among those with charitable (and tax liability reduction) goals is to use a life insurance policy to replace values of properties given to a charity through a charitable remainder trust. You contribute your properties to a charitable remainder trust and you (and your loved ones after your death) receive an income stream in the form of either a fixed annuity or a payment based upon a percentage of the value of the trust’s assets. At the end of specified period, often when a death occurs, a certain percentage of trust assets go to a designated charity.
In order to replace trust assets that have been given to charity, many families fund life insurance with an income stream generated from the charitable remainder trust. This can substantially increase the payments to your loved ones, tax-free.
Five Steps to Begin Planning with Life Insurance
If you think that incorporating life insurance (either directly or as a trust asset) into your estate plan may be a good option, here are five steps you can take now to get the ball rolling:
- Know the Value of Your Estate. First, you need to know the value of your estate. Will your loved ones have the money they need without life insurance? Will your loved ones have a substantial estate tax bill if you do not plan accordingly? These are critical questions for determining whether life insurance makes sense for your personal circumstances.
- Assess Future Needs of Your Loved Ones. If your estate is likely to fall short of meeting the needs of your loved ones, how much life insurance should you purchase? You want to make sure your coverage is sufficient, but you also do not want to waste money on unnecessary premiums.
- Research Potential Issuers. Like all types of insurance, life insurance issuers are a dime a dozen. Different issuers offer different coverage options, different premiums, and different levels of client service, and these are all issues you should consider when planning for your loved ones’ future needs.
- Choose Your Beneficiaries. When you read, “loved ones,” who comes to mind? Your spouse? Your children? A dependent sibling or parent? You need to decide who will be entitled to the proceeds of your life insurance policy after your death.
- Choose a Trustee. If you are going to establish a life insurance trust or a charitable remainder trust, who (or what charity) will you choose to serve as the trustee? For an ILIT, it is important to choose someone who is both able and willing to administer your trust effectively. For a charitable remainder trust, your options are vast, and you need to make an informed decision based upon your personal interests, your research of different charitable organizations, and a number of other pertinent considerations.
Schedule an Estate Planning Consultation at Jiah Kim & Associates
If you would like more information about incorporating a life insurance policy into your estate plan, contact Jiah Kim & Associates. To schedule an initial estate planning consultation, call (646) 389-5065 or choose an available slot on our calendar now.
This blog post is written for educational and general information purposes only, and does not constitute specific legal advice. You understand that there is no attorney-client relationship between you and the blog publisher. This blog should not be used as a substitute for competent legal advice from a licensed professional attorney in your state.