How to Create an Effective Estate Plan Using Life Insurance

Life insurance can be an effective tool when you’re planning to bequeath assets. 

Most people in the United States have outstanding debt when they pass away, leaving creditors to go after their remaining estate, including financial accounts, real estate, and possessions (think jewelry, cars, antique furniture, etc.). 

Generally, creditors will seek all estate values, pay back debts, then divide what remains among beneficiaries or heirs. 

There are, however, ways to arrange assets so that they are not subject to probate in most states.

Life insurance is one way to protect your assets for the future, providing your beneficiaries with increased liquidity, tax advantages, more control of assets, and higher income and cash flow.

Who Needs An Estate Plan?

Any individual who wishes to pass their assets on to a beneficiary once they pass away should work with a financial advisor or legal team to develop a formal estate plan.

Having the legal documents prepared will greatly ease the beneficiary’s experience. It will also ensure that said individual’s wishes are followed if they are not able to be present when transferring the estate.

Estate plans are not just for the wealthy. You don’t need to be old or married with a family to have one, either. 

An estate plan is simply a way to maintain control of your assets rather than leaving it up to the state.

Even people with no children or family can use an estate plan to leave their assets to friends or an organization that they care about. 

While many people could benefit from an estate plan, the following individuals should prioritize having one:

• People with children who may need a guardian
• Property or business owners
• Those with large families 

Additionally, if you want to maintain control over who gets what of your assets, you’ll need to make a legal plan to avoid disputes in the future.

Sadly, it is not unheard of for families to fall apart after a loved one’s death due to disagreements over assets.

Should You Use Life Insurance?

Taking out a life insurance policy is a strategy many financial planners recommend to protect assets if you pass away suddenly and/or prematurely. When someone dies without life insurance, the transition of assets becomes even more muddled. 

There are a variety of reasons to use life insurance as a tool. However, it is always advisable that you speak with your attorney or financial advisor before investing in a specific policy.

Nevertheless, here are a few benefits of using life insurance for your estate plan.

Quick Access to Policy Benefits

Life insurance allows your declared beneficiaries immediate access to funds. 

Normally, in sudden or premature death, the estate of the person who passed away is subject to probate. 

Probate is the authentication of the deceased’s last will and testament under a court’s supervision, which can take months to be processed.

 It includes determining the value of the estate itself, any owed debts, and the distribution of remaining funds to beneficiaries.

However, if the deceased has placed assets in a life insurance policy, they can be accessible much more quickly. 

Insurance providers do not require as many documents as the court, so generally, with just a death certificate, liquidity can be made available. 

Families can use the money to cover everyday expenses and plan for any funeral or burial costs, which can make a significant difference for a grieving family.

Tax Advantages

Life insurance policies are also generally not subject to inheritance tax, allowing you to maximize payouts for beneficiaries legally. 

The policies vary, so again, we suggest you discuss this with your attorney or financial advisor to ensure you can pass on as much of your wealth as possible to those you choose instead of the state itself. 

More Money for Your Beneficiaries

Additionally, by taking out a life insurance policy, your beneficiaries generally will receive more than if you don’t. 

Although life insurance may seem somewhat expensive, the payout is usually greater than the investment in the long run.

Should You Use An Irrevocable Trust?

According to Investopedia, an irrevocable trust is “a type of trust where its terms cannot be modified, amended or terminated without the permission of the grantor’s named beneficiary, or beneficiaries.” 

The grantor is giving all control of the trust to the grantee. This is another option to consider when planning for the future of your estate. 

The benefit of setting up an irrevocable trust is that it removes assets from the grantor’s taxable estate. 

The trust can include assets such as

• A company
• Investments
• Cash
• Life insurance policies 

By endowing a life insurance policy through the use of an irrevocable trust, grantors remove death proceeds from the estate.

Irrevocable trusts are ideal for high net worth individuals working in professions that may be prone to lawsuits, such as doctors or lawyers themselves. 

By passing the control of assets to a beneficiary, they are inadmissible for post-mortem legal proceedings. 

Limitations to Using an Irrevocable Trust

There are some limitations to placing assets in an irrevocable trust. 

• Costly: Legally, an irrevocable trust is a very complex arrangement that may be expensive to set up. They can also incur current income tax and future estate tax implications. 
• Unchangeable: Irrevocable trusts are, in fact, irrevocable. The grantor loses all control of any assets in the trust, and if they desire to make changes, it can require all adult beneficiaries’ permission.

Alternatives to an Irrevocable Trust

• Revocable trust: A revocable trust can be changed or terminated as long as the grantor is mentally competent. The downside is that the assets included in the trust are considered the creator’s property and are therefore subject to tax and affect government benefits. 
• Gift: Gifting a life insurance policy to a spouse or child is another viable option to protect assets. Providing the policy’s amount is under the annual gift tax exclusion, which varies by state, the recipient of the gift would not be required to pay any tax and assets would be protected. 

If you plan to give a policy as a gift, beware of the three-year rule. Any policy that is considered a gift is liable to estate tax if the grantor passes away within three years of said gift. 

How to Fund Your Life Insurance Purchase

If you’ve decided to invest in a life insurance policy to secure your estate, you’ll need to do some research on how you want to finance that policy. 

Generally speaking, life insurance is a contract between an individual and an insurance company that ensures payment of a death benefit to named beneficiaries should the insured pass away. 

There are various ways to fund a life insurance policy. 

The most common types of payments are lump sum payments, where the insured pays a premium up front, or recurring premiums paid over time. 

Let’s take a closer look at the options:

Lump Sum

Otherwise known as single-premium life insurance (SPL), lump sum life insurance allows the insured to pay a single premium into the policy to guarantee a death benefit throughout the course of their entire life.

SPLs are fully funded by the insurance company. The amount of the payout to beneficiaries is contingent on the lump sum premium, as well as the age and overall health of the insured. 

Insurance companies invest the lump sum premium so that it has the opportunity to grow over the lifetime of the insured, meaning premiums may be lower for younger, more healthy individuals.

Some SPL policies allow the insured to access funds for long term care tax-free if needed. Any funds that are not spent will still go to the named beneficiaries tax-free as well. 

There are various policies to investigate, including some that also allow for access to funds in the case of illness or imminent death.

Over Time

The other way to fund your life insurance policy is by paying multiple premiums over time. 

Most insurance companies will offer the purchaser a variety of modes of premium, meaning you can choose how often you make payments. 

The most common modes of premium are:

• Annual
• Semi-annual
• Quarterly
• Monthly

Many insurance providers also allow the insured to adjust their mode of premium over the course of their lifetime. 

Although a single up front payment may be painful at the time, overall the savings will be greater. 

As a general rule, if you opt for ongoing premium payments, the less frequent the payments, the lower your life insurance cost will be.

How to Transfer Wealth

There are many ways to transfer wealth efficiently, ensuring that the beneficiary is receiving the most money possible. 

Gifts, direct payments, and retirement fund conversions are only a few of the myriad options. 

Transferring wealth is complex and usually requires a knowledgeable attorney’s assistance, but here are some tips depending on the intended beneficiary.

To Family

The most common and effective way to transfer wealth to family is through gifts under the annual taxable limit. 

You can do this by gifting a life insurance policy, or directly writing a check. 

You may want to transfer wealth to children or grandchildren for educational purposes, in which case it can be put into a 529 college savings plan, where it can grow tax free. 

These plans allow the beneficiary to withdraw funds for qualified educational expenses tax free. 

To a Business

Take a tip from the Rockefeller family and keep your wealth within your business. 

By doing so, you can avoid familiar disputes and ensure your children keep your entrepreneurial spirit going. 

By creating a joint family trust in the name of your business, you can maintain some control even when you’re not physically around.

To Charity

If you’d like to contribute your wealth to a charity, you may consider a donor advised fund. By doing so, you also receive charitable tax deductions. 

You can control where the fund’s wealth is directed, be it to a church, a charity, or a university. 

Additional members can be added to the fund, allowing more money to be moved to the elected institutions. The only downside is any wealth in the fund can’t be taken back.

Who Do You Need to Get Involved?

When planning your estate, it is important to ensure you are completely clear on all that is being decided and arranged. 

Determining the best way to bequeath assets to loved ones or important organizations should not be taken lightly, so it is advisable to seek legal counsel.

Most lawyers can write a straightforward will, but there are attorneys who specify in trust-and-estate planning. 

With a background in legal finance, they will be able to help you maximize the amount of the estate that goes directly to your beneficiaries as opposed to the state itself. 

While some taxes are unavoidable, a good estate attorney will know how to build you a comprehensive plan based on your own situation.

You’ll want to involve your financial advisor, and you’ll also want to draft a durable power of attorney (POA) giving someone you trust the ability to manage your estate should you be unable to. 

In the case of severe illness or sudden death, the absence of a POA could leave your estate’s fate in the hands of the courts, meaning your loved ones will have no control.

What if Plans Change?

Estate planning can be daunting, but the purpose of the exercise is to maintain control of your assets no matter what happens. 

By investing in a life insurance policy as a part of your estate plan, you are already ensuring that your wealth will resist unforeseen circumstances. 

It is customary for people to review their estate plans regularly to account for changes in financial planning overall. The norm is to review plans annually, semi-annually or quarterly. 

Some life events warrant meeting with an attorney to review the plan. These may include:

• The birth of a child or grandchild
• Child or grandchild becomes a legal adult. 
• The death of a named guardian
• Changes in the number of dependents
• Marriage
• Divorce
• Change in assets such as buying a home or receiving a financial gift

How Do Taxes Come Into Play?

As mentioned before, hiring a professional estate agent, legal associate, or financial planner can help you keep your assets under you and your beneficiaries’ control instead of going to the state. 

The main goal of estate planning is to transfer your assets while paying as little in taxes as possible. 

This is not irresponsible, it is sensible. The earlier you begin your plan and start making periodic adjustments as the tax code evolves, the better you and your loved ones will fare.

Planning for the legal transference of your assets is imperative since estate and gift taxes are individually reviewed by the Internal Revenue Service (IRS). 

The chance that your finances will be audited are higher. By working with an attorney, you should be able to save your loved ones any headaches.

Final Thoughts

Estate planning is an incredibly complex process that requires continuous maintenance and review. 

However, by working with a professional to plan your estate, you ensure your loved ones will receive the fruits of your labor no matter what your net worth is. 

Life insurance is a great option to consider when building your estate plan with your attorney.