Although Samuel, Sayward & Baler LLC does not sell life insurance, they do assist clients in planning for the future of their families, and life insurance is frequently a part of that planning. Here are five things to think about when buying or canceling a life insurance policy in the context of your estate plan.
1. For young families, life insurance is an excellent planning tool. Young couples that are just starting in life may not always have a lot of assets. Because they are just starting in their careers, their incomes are not yet at their height. They may also be saddled with hefty student loan debt or a large mortgage.
The birth of a child is frequently the catalyst for them to buy life insurance so that if one of them dies, the surviving spouse will be able to stay in the house and raise the children. When deciding whether and how much life insurance to buy, consider factors such as how the loss of one spouse’s income will affect the family’s capacity to pay expenses and educate the children.
2. Life insurance is taxable in the estate of the insured (often). Many people are unsure whether or not life insurance is taxable. Life insurance proceeds are usually not taxed to the individual who gets them. If my aunt chooses me as the beneficiary of her $100,000 life insurance policy, for example, the $100,000 is not taxable income to me.
However, if the insured held the policy or had the authority to cancel, surrender, assign, or modify the policy’s beneficiary, the proceeds are a taxable asset of the insured’s estate. As a result, while I will not pay income tax on the $100,000 in life insurance proceeds left to me by my aunt, those proceeds will be included in my aunt’s taxable estate and will increase my aunt’s estate tax burden if her estate is big enough to necessitate payment of federal or state estate tax.
3. Life insurance can be a simple solution to a difficult problem. Life insurance is a good way to deal with a situation that is causing you stress when it comes to planning. For example, spouses in a second marriage who wish to leave pre-marital assets to children from a previous marriage but still want to take care of their spouse could buy life insurance that pays out to the surviving spouse while the pre-marital assets benefit the children. Business owners who wish to ensure that their surviving partners have enough money to keep the company running might get life insurance on each other or through the company.
Parents who wish to retain a beloved vacation house in the family but recognize that the costs of upkeep will be a burden on their children can use life insurance to give funds to cover the costs of upkeep after they pass away. Families with a special needs child can utilize life insurance to fund a trust for the child to ensure that monies are accessible for the child’s entire life to provide for housing and other necessities.
4. Life insurance is a viable option for paying estate taxes. Life insurance can be an excellent option to provide liquidity to pay that tax, which is due nine months after death for persons who have a taxable estate (i.e., more than $11.7 million federally in 2021 and $1 million in Massachusetts). If, on the other hand, the deceased owns the life insurance policy, the proceeds are added to the taxable estate, raising the estate tax liability.
When life insurance is purchased and held in an irrevocable trust, the proceeds are not included in the insured’s taxable estate, protecting the full value of the policy for the family. The irrevocable life insurance trust may become a more popular planning instrument as Congress considers lowering the estate tax exemption threshold to $3.5 million and raising the federal estate tax rate.
5. Regularly review your life insurance policy. Life insurance is not a transaction that should be made once and then forgotten about. As time passes, requirements change, and life insurance purchased ten years ago may no longer be enough or necessary. The premiums for so-called “term” life insurance are fixed during the term, but the policy will terminate or the premiums will considerably increase after the term ends.
Term insurance can be a great method to cover a short-term need, such as paying for a child’s school or paying off a mortgage. The objective for which the insurance was obtained becomes irrelevant once the children have graduated from college or the mortgage has been paid off. If you want the insurance money to go toward supporting that vacation house you’re leaving your children or funding a trust for a special needs child, a policy that will expire is generally not the best option.
Life insurance, in my experience, is usually more complicated than it appears at first glance. To ensure that you purchase and retain insurance that meets your goals and is best suited for your needs, you should work with an experienced life insurance agent, a financial planner, and an estate planning attorney, and own it in a way (in your name or irrevocable trust) that works with the rest of your estate plan.