Key Takeaways
Life insurance has many valuable uses beyond providing for loved ones.
The right life insurance can be a powerful estate planning tool for wealth transfer and estate liquidity to cover taxes and debts.
Irrevocable Life Insurance Trusts (ILITs) can remove life insurance proceeds from taxable estates, protecting assets from creditors and ensuring smooth transfer to heirs.
My last post Life Insurance Essentials: Beyond the Sales Pitch generated several questions and comments. So, I thought I’d spend a little time discussing the smart use of life insurance when it relates to estate planning. When people ask me which type of life insurance to get, I tell them it depends upon their health, insurable needs, goals, and what they want to leave their heirs. First, let’s recap the different general types of life insurance:
1. Term Life - is the most basic and affordable form of life insurance. It provides your family with income protection if you die or become disabled during your prime working years. The term (increments of five or ten years) and the premiums are fixed. Unlike whole life, term life policies don’t build up cash value, so there’s nothing left to pass on to your heirs if you don’t use it during the term. But again, it’s the most affordable option and the death benefit gives you and your family peace of mind.
2. Whole Life - offers coverage for your entire lifetime rather than a fixed term. The policy has a cash value that grows over time at a guaranteed rate. However, the premiums are typically much higher than they are for term life, but they are fixed for the life of the policy. For example, if you purchased a $1 million, 30-year term life policy at age 40, your premiums might be $1,200 a year vs. $8,000 to $9,000 a year for whole life insurance.
3. Universal Life - is a whole-life policy, but with a cash value component that is tied to interest rates or market indices. However, universal life offers more flexibility in the premium payments than whole life or term. Your premiums will fluctuate depending on how the underlying cash is performing.
So, how else can life insurance be used? Hint: Not as an investment.
Life Insurance For Estate Planning
When people hear “life insurance,” they typically think of life and income protection. However, life insurance is also a powerful estate planning tool. Many people are not affected by the estate and gift tax exclusion today, because it’s historically high around $12.5 million per person ($25 million for married couples). However, starting in 2026, the estate and gift tax exclusion threshold will likely be cut in half, if not more, impacting many. By incorporating insurance into your estate plan, you can cover those estate taxes and ensure the wealth you're transferring to heirs is not eroded by taxes. Whole life insurance is also a good tool for addressing liquidity issues (see below).
Example - The adult children from a local family inherited the family farm after both parents passed. The farm was valued at about $12 million. Since the transfer occurred back in 2006 when the estate tax exclusion threshold was only $2 million (instead of $25 million today) they were looking at a significant tax hit. Since there were no other liquid assets left in the parents’ estate when the kids inherited the farm, they didn’t have the money to pay the estate taxes. They thought their only option was to sell it. That was not something the kids wanted to do since the farm had been in the family for generations and they wanted to keep it that way.
ILITs
So, it was recommended to use an irrevocable life insurance trust (ILIT) for the family above, which removes the life insurance proceeds from the taxable estate. That way the death benefit is distributed to the beneficiaries according to their wishes, without increasing their estate tax liability. With an ILIT, the premiums they pay are gifted to the trust. Because they’re gifts, the money is outside of the taxable estate. So, the trust owns a life insurance policy and manages the distribution of the proceeds.
Tools like ILITs, that combine life insurance and estate planning, are smart ways to transfer assets out of your estate. Even better, most life insurance policies are creditor-protected. If you get sued or divorced, creditors and ex-spouses can't come after the insurance policy. You’re especially well protected when the policy is wrapped within a trust.
Debt Reduction
Whole life insurance can also be useful if you have an estate with lots of debt outstanding. For instance, let’s say someone has a real estate portfolio of nine properties and each property has a mortgage on it. The whole life policy can be used to pay off all the mortgages.
Whole life can also be used to ensure business continuity. Let’s say you own a business that’s worth $10 million and your beneficiaries will be inheriting the business. Life insurance can fund a buy-sell agreement and ensure the smooth transition of ownership and it provides enough liquidity to cover any other financial obligations.
Second-To-Die Policy
When couples start collaborating with us, they often ask if they should each get a whole life policy in their name. Instead, we often recommend a second-to-die policy that covers both the husband and the wife. That way the premiums are paid up until the death of the second-to-die spouse. Only then does the policy go to the beneficiaries. In most cases, the premiums on a “second-to-die” policy are lower than if the couple gets two separate policies.
Example - A widow we have long worked with just passed away. Her husband died in 2015. The premiums on the couple’s longstanding second-to-die policy were paid in full back in 2009, so the policy is now worth about $1.8 million. Now that both of them have passed, the money will transfer to their children. Back in the early 2000s, when the couple took out the policy, the estate tax exclusion in New Jersey was only $675,000. They were aggressive about looking for ways to shield their assets from taxation and they didn’t want their children to be stuck with a big tax bill to cover estate taxes. Their strategy paid off handsomely.
If you need help with insurance, as fee-only financial advisors we collaborate with several independent brokers who can help you shop for policies from multiple providers. We provide unbiased recommendations for what is best for your needs. Helping clients find the right insurance provider is part of our standard assets-under-management fee.
Conclusion
If you or someone close to you has concerns about your insurance coverage or other asset protections, reach out any time. I’m happy to assist.
DAN SATZ MS, CFP® is a Partner at Novi Wealth
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