As the amount that can be left estate-tax free increases each year ($5.45 million as of 2016), clients continue to ask me why they should keep their life insurance or whether they should even be considering the purchase of new life insurance.
Historically, a significant portion of life insurance was purchased for the purpose of planning for estate taxes. The insurance proceeds at death create liquidity for an estate, ensuring that cash will be available to pay the estate tax, and other assets can be retained and passed down in the family. For those families that do need life insurance to help pay for estate taxes, they should review how the life insurance is owned to make sure that the life insurance proceeds themselves will not be subject to estate taxes.
For those families that do not need life insurance to help pay estate taxes under the current law, there are other reasons why life insurance is an important estate planning tool.
Your family may lose income if you or your spouse were to pass away. The loss of income may result in your family being forced to move, or may create other economic issues, including not being able to pay for education.
Life insurance can serve as an income replacement to help your family continue to pay for their expenses.
Many families have a significant asset, such a business or rental estate, in which one child is actively involved and another is not. If all of the assets are left equally to the children, the child who is not involved in the business now owns a portion of the business or real estate but otherwise has nothing to do with it. This can create problems between the siblings and issues with continuing management of the enterprise.
By purchasing insurance, a family may create enough liquidity at death to allocate a specific asset to one beneficiary and provide cash to the other beneficiary, ensuring that everyone benefits equally, and the business (and sibling relationship!) is not adversely affected.
Business Planning
Co-owners of a business often enter into a buy-sell arrangement which states, in general, that if one owner dies, the other co-owner will buy the deceased's family out of the business. This allows the deceased's family to benefit from the business but gives the surviving owner full ownership and control of the business.
Similar to the beneficiary planning discussion above, the dilemma is how the surviving owner will pay for the portion of the business to be purchased. In order to avoid having an ongoing debt to the family and to avoid having this debt show up on the books of the business, each owner should purchase insurance on the other in an amount sufficient to buy out the deceased's share of the business. The surviving owner collects the life insurance proceeds and pays them to the deceased's family in exchange for the interest in the business.
Whether existing life insurance should be kept, or new insurance should be purchased, is a discussion that everyone should have with their estate planner and other advisors on an ongoing basis. Existing policies should always be reviewed to ensure that the insurance is still appropriate based on its original purpose and changing circumstances.
Additionally, the trustee of an irrevocable life insurance trust (ILIT) should meet with the trustee's advisors at least annually to discuss tax and other considerations which are essential to carrying out the purpose of the insurance.
Finally, a review of the beneficiary designations should always be part of reviewing the policy itself, since all of the planning discussed in this newsletter requires the insurance to be paid out in a specific way upon the death of the insured.
