When do you carry life insurance? Typically, when kids are young and money is tight. That’s when it’s most important to protect against the horrible, if unlikely, possibility of dying and leaving your family broke as well as bereft. Term life insurance, the least expensive variety of life insurance, has remained a popular choice among young families since it was introduced several decades ago.
Because term life is purchased for a specific period of time-20 years is common-many policyholders choose to drop their policies at the end of the term. Families who have successfully grown their financial estate often realize that they no longer need the protection of life insurance, especially once children are grown and independent.
There are other uses for insurance, so before you surrender your policy, take the opportunity to confer with us. Some types of insurance, such as universal life, can play an important role in tax and estate planning, particularly for people who own businesses or have accumulated large estates. You may find that insurance provides a good solution to save on taxes and protect your estate in these and other situations:
(1) If your estate is worth more than the estate tax exclusion ($5.49 million in 2017), your heirs can use the proceeds from a life insurance policy to pay estate taxes. Often, heirs will find that they must sell some assets-such as real estate or art collections-in order to cover estate taxes. A life insurance policy can prevent heirs from having to say goodbye to family assets and mitigate the risk of having to sell when asset values may be down.
(2) You can also use life insurance as a way to give to charity without reducing the size of the estate for your beneficiaries.1
(3) If you own a business, life insurance should be part of your succession planning. “Key person” policies can keep the business running until it is sold or a new executive is hired; or, the policy can fund a buyout by a partner. If one of more of your heirs has been active in the business and the plan is to leave the business to them, proceeds from a life insurance policy can buy out other heirs who will not inherit the business-reducing strain on the business as well as family fights.
Payment of a death benefit from a life insurance policy is typically not a taxable event. The IRS views a death benefit as income replacement or a reimbursement of loss, not taxable income. So payments to a surviving spouse are not taxed by the IRS unless the policyholder’s entire estate is large enough to be subject to estate tax. For these larger estates, insurance proceeds may be taxed unless the policy is held in an irrevocable trust. In that case, the policy is not considered part of the estate and would likely not be subject to federal tax.2,3
Life insurance can provide meaningful estate and tax planning benefits if you understand how to effectively use it. Consult with us and an estate attorney to help you maximize the benefits of a policy for both you and your heirs.
1Napa Valley Wealth Management: Benefits of life insurance
2The Simple Dollar: The Tax Benefits of Life Insurance
3Motley Fool: 2017 Estate Tax Rates