By: AVID Esq. Group LLC July 6, 2023

Estate Planning with Life Insurance: Beyond the Policy

Understanding Life Insurance and Estate Planning

Types of Life Insurance Policies

When planning your estate, it’s essential to understand the different types of life insurance policies available. Whole life and term life insurance are the two main categories:

Whole Life Insurance: This policy provides coverage throughout your entire lifetime, as long as you pay the premiums. It also accumulates cash value, which can be used as collateral for loans or withdrawn for other purposes.
Term Life Insurance: This policy provides coverage for a specific term, such as 10, 20, or 30 years. If you pass away during the term, your beneficiaries will receive the death benefit. These policies do not accrue cash value.

Consider your financial goals, family needs, and budget when choosing the right policy for your estate planning.

Estate Planning Goals

Life insurance can play a crucial role in achieving your estate planning goals. Here are some common objectives and how life insurance can help:

Income Replacement: Life insurance can provide immediate financial support for your loved ones after your passing, ensuring they don’t face financial hardship due to lost income.
Debt Repayment: The death benefit from a life insurance policy can be used to pay off debts, such as a mortgage, credit cards, or student loans, removing financial burdens from your beneficiaries.
Estate Taxes: Life insurance can cover estate taxes if your estate faces a substantial tax bill. Using the policy to pay these taxes can prevent your beneficiaries from having to liquidate other assets.

By incorporating life insurance into your estate planning, you can ensure that your family and loved ones are financially secure in the event of your passing.

Including Life Insurance in Your Estate Planning Strategy

Life insurance can be a valuable tool in your estate planning strategy. It can provide financial support to your loved ones, help cover funeral costs, and pay off any debts.

In this section, we’ll discuss three ways to include life insurance in your estate planning strategy: Creating a Trust, Transfer of Ownership, and Using Beneficiary Designations.

Creating a Trust

Establishing a trust, specifically an irrevocable life insurance trust (ILIT), can offer multiple benefits for your estate planning. By placing your life insurance policy inside an ILIT, you can:

Avoid estate taxes: Since the trust becomes the owner of the policy, assets within the trust will not be included in your estate, reducing your estate’s tax liability.
Control distributions: With an ILIT, you can decide how and when the policy’s benefits are distributed to your beneficiaries.
Protect assets: Assets within an ILIT are generally protected from your beneficiaries’ creditors.

To create an ILIT, you’ll need to work with an estate planning attorney – like us at AVID Esq Group if you’re in Arizona or Colorado – who can help you draft the necessary documents and guide you through the process.

Transfer of Ownership

Another strategy for including life insurance in your estate planning is transferring the ownership of your policy to a family member or other individual. This can also help reduce your estate’s tax liability.

However, it’s important to be aware of the potential drawbacks:

Loss of control: Once the policy is transferred, you no longer have control over it.
Gift tax considerations: If the policy’s cash value exceeds the annual gift tax exclusion, you may be subject to gift taxes.

To transfer ownership, you’ll need to contact your life insurance provider and complete the necessary paperwork.

Using Beneficiary Designations

Naming beneficiaries on your life insurance policy is a simple way to ensure that the proceeds go directly to your loved ones when you pass away.

While this strategy might not offer the same level of control and asset protection as a trust or transfer of ownership, it’s an efficient and straightforward option.

When naming beneficiaries, consider the following best practices:

Name a primary and contingent beneficiary: This ensures that if your primary beneficiary predeceases you or cannot accept the benefit, the contingent beneficiary will receive the proceeds.
Review and update regularly: Keep your beneficiary designations up to date, especially after major life events like marriage, divorce, or the birth of a child.

By incorporating life insurance into your estate planning strategy, you can help ensure that your wishes are carried out and that your loved ones are financially secure after your passing.

Tax Considerations for Life Insurance and Estate Planning

Managing Estate Tax Exposure

In estate planning, life insurance can play a crucial role in helping you manage your estate tax exposure. Currently, if you were to pass away in 2023, you could pass $12.92 million ($25.84 million per married couple) to your heirs without paying any federal estate tax under the Tax Cuts and Jobs Act of 2017.

One strategy to consider is holding life insurance within an irrevocable life insurance trust (ILIT). By transferring ownership of life insurance policies to an ILIT, you can remove the policy from your taxable estate, reducing or potentially eliminating estate taxes. Additionally, the ILIT will ensure that policy proceeds are used according to your wishes.

Income Tax Implications

Life insurance proceeds are generally income tax-free to beneficiaries. However, there are certain situations in which the proceeds can be subject to income tax. For instance, if you withdraw cash from a permanent life insurance policy, any gains above the policy’s cost basis can be subject to income taxes.

To minimize income tax surprises and maximize the overall benefits of life insurance in estate planning, consider these tips:

Consult with professionals: Seek advice from tax experts and estate planning attorneys to create a comprehensive plan tailored to your specific tax and estate objectives.
Review policy ownership: Carefully evaluate the ownership structure of your life insurance policies, considering factors such as marital status, the number and age of children, and the size of your estate.
Consider policy loans: When necessary, explore borrowing against your life insurance policy, as loans are generally not taxed. However, be aware of potential pitfalls, such as loan interest and the possibility of the policy lapsing.

Life insurance can be an effective tool for managing your estate’s tax exposure and providing financial support to your heirs. By carefully evaluating tax implications and working with experienced professionals, you can create an estate plan that fully utilizes the benefits of life insurance.

Special Situations and Considerations

Blended Families

When planning for estate distribution in blended families, life insurance can play a crucial role in ensuring a fair and balanced allocation between all family members.

Multiple life insurance policies may be necessary to cover different needs and beneficiaries.

For example, you might purchase one policy to take care of your spouse’s needs and another to support your children from a previous marriage.

By having separate policies, you can ensure that all beneficiaries receive the designated financial support according to their needs and circumstances.

Business Succession Planning

Life insurance can also be an essential tool in business succession planning. If you are a business owner, consider purchasing a life insurance policy and making the business a beneficiary.

This can help provide a financial safeguard in the case of your unexpected passing, which may otherwise cause financial instability for the company.

Buy-sell agreements, funded by life insurance policies, are also useful to facilitate the smooth transfer of business ownership between partners when a partner dies.

Each partner buys a life insurance policy on the other partners, naming themselves as beneficiaries.

Should a partner pass away, the surviving partners use the life insurance proceeds to purchase the deceased partner’s share in the business, ensuring a smooth transition and financial stability for all parties involved.

Managing Fiduciary Liability

As a policyholder, you have the responsibility to manage your life insurance policy and ensure the policy’s intended purpose aligns with your estate planning goals.

To minimize fiduciary liability, select a reputable insurance company and update your beneficiary designations as necessary to reflect your current intentions and family situation.

Regular Reviews and Updates

Life Changes Impacting Your Plan

It’s important to regularly review and update your estate plan, especially considering how life insurance can play a key role in it. Life changes can significantly impact your estate plan, so it’s essential to revisit it when you experience events like marriage, divorce, birth or adoption of a child, a change in financial status, or retirement. By doing so, you’ll ensure that your estate plan remains current and reflective of your wishes.

Remember, life insurance can be a valuable tool in estate planning, as it provides financial support for your loved ones and can help cover estate taxes. Make sure to reassess your life insurance policy when these life changes occur to avoid any unintended consequences.

Policy Reviews

In addition to life events, it’s good practice to review your life insurance policy every few years or whenever significant changes happen. This will help you stay on top of any updates needed and ensure that your policy aligns with your overall estate planning objectives.

During these policy reviews, consider evaluating the coverage amount, beneficiaries, and any additional riders. Check your policy for any clauses or restrictions that might hinder your estate planning efforts.

For instance, you may want to confirm that your life insurance policy is properly structured to avoid creating a liquidity crunch in your estate or leaving your beneficiaries with unexpected tax liabilities.

Regular reviews and updates to your estate plan and life insurance policy are crucial to ensure they remain effective and in line with your personal goals. By staying proactive, you’ll be able to navigate any life changes and keep your estate planning strategy on track.

Choosing Professional Advisors

Estate planning with life insurance can be a complex process, and it’s essential to work with the right professional advisors to ensure your assets are properly managed and distributed according to your wishes.

In this section, we will discuss selecting an estate planning attorney and working with a financial advisor.

Selecting an Estate Planning Attorney

When selecting an estate planning attorney, you should consider several factors:

Experience: Look for an attorney with a proven track record in estate planning and life insurance matters. They should be knowledgeable about the laws in your state and experienced in creating comprehensive plans that incorporate life insurance.
Reputation: Seek out an attorney with a strong reputation, both in the legal community and among their clients. This can provide a sense of trust and confidence in their ability to handle your estate planning needs.
Accessibility: Make sure the attorney is readily available to answer your questions and address any concerns. You should feel comfortable discussing your estate planning matters with them.
Customization: Find an attorney who understands your unique situation and can devise a tailored plan that meets your specific needs.

For estate planning services in Arizona and Colorado, we recommend Aaron Fransua at AVID Esq Group. Aaron has extensive experience in estate planning and is dedicated to helping clients protect their assets and leave a lasting legacy for their families.

Working with a Financial Advisor

In addition to an estate planning attorney, it’s important to work with a financial advisor who can help you make informed decisions regarding your life insurance and other financial assets.

Here are some tips for working with a financial advisor:

Credentials: Verify the financial advisor’s qualifications, certifications, and licenses to ensure they have the necessary expertise to assist you.
Understand Your Needs: A good financial advisor should take the time to understand your financial goals and unique circumstances. They should be able to work closely with your estate planning attorney to help optimize your life insurance strategies.
Communication: Establish clear lines of communication, and ensure your advisor is available to answer any questions or provide updates on your financial plan.

By partnering with the right estate planning attorney and financial advisor, you can confidently navigate the complexities of life insurance and estate planning to ensure a secure future for your family.

Estate Planning With Life Insurance FAQs

Integrating life insurance into your estate planning is more than just securing financial support for your loved ones; it’s about leveraging tax benefits, managing wealth, and cementing your legacy.

However, tailoring life insurance to fit seamlessly into your estate plan is a personalized and intricate process. It demands a deep understanding of your finances, goals, and current estate provisions.

That’s where AVID Esq Group in Gilbert, Arizona, steps in.

Our experienced attorneys are ready to guide you through the complexities of estate planning with life insurance, helping you craft a plan that’s uniquely tailored to your needs and aspirations.

After all, your legacy deserves nothing short of the best.

Don’t wait, schedule a free consultation with us today and secure your legacy with confidence.