In estate planning, the stakes are quite literally life and death. Contemplating what happens to your worldly possessions after death is not the most pleasant thought experiment, but failing to do so could cause a world of unnecessary stress, strife and paperwork for the people who are left behind. Whether one is a young professional laying financial foundations or an industry veteran eyeing retirement, men and women have everything to gain from settling their affairs ASAP — and everything to lose from leaving it late.
“Estate planning is not just for the wealthy. It is a process that every adult should undertake,” said Victor Werley, certified financial planner and founder of the financial consulting firm Pinnacle Advisors. “The fact is that we are all going to die, and someone will have to address your estate, no matter how large or small it is. For many people, the process of estate planning is less focused on the dispensation of your assets than it is focused on creating proper end-of-life plans and proper powers of attorney for your financial and medical affairs. This is something that we all must face, even if we don’t have a huge estate.”
Life insurance can be a vital component of an effective estate plan, thanks to its multiple strategic uses, from covering final expenses and clearing remaining debts to making up for lost income. While the specific rationale behind the life insurance policy will depend on an individual’s unique circumstances, “life insurance should always be considered as a part of an estate plan,” Werley said.
“I have seen a lot of estate plans that contain so many diverse assets that the life insurance is used to protect the plan, but it isn’t the primary wealth driver. Other times, the life insurance can be 90 percent or more of the overall estate.”
In the case of larger estates, an effective life insurance policy can also be a helpful tool for addressing the resulting tax burden.
“When properly designed, a life insurance policy provides the necessary liquidity to pay any estate taxes that may be due at the death of the insured,” said Jason Prather, JD, LLM, managing principal at wealth management firm Legacy Capital Group. “This helps prevent having to liquidate estate assets, or leverage them, in order to generate the cash required to pay the tax.”
For those whose wealth is concentrated in valuable assets as opposed to cash, the lack of an insurance policy can force surviving loved ones into the compromising position of having to sell off family heirlooms or other treasured items to raise money. Depending on the market and the timing of the death in question, families also run the risk of needing to sell items for less than they’re actually worth.
Life insurance can also be useful for equalizing an estate between multiple children, as well, Prather added. If some children work in the family business while others do not or if the children have conflicting ideas of what to do with an inherited property, the life insurance payout can help each child receive their fair value from the estate and prevent disputes over how exactly to divide the assets.
There are many different kinds of policies on the market, and some are better suited to estate planning than others. The items in the estate and how they can be expected to appreciate or depreciate over time will dictate the best policy options.
“Having the wrong type of insurance can be almost as devastating as not having any when you need it,” Werley said. “In some cases, with a declining debt combined with growing assets, the correct answer could be a term policy that falls off at the appropriate time. Other times, there can be taxes or other growing liabilities associated with the estate which would necessitate using a permanent life insurance solution to ensure a complete plan.”
In general, a permanent need for coverage should be addressed with a permanent policy, such as whole life or universal life, while temporary coverage needs can often be satisfied with the appropriate term policy. The type of permanent policy used will depend on the specifics of the estate plan itself, Prather said.
“It may be an individual policy insuring one person, or it may be best to use a policy that insures two people, such as a husband and wife together. Many estate plans, when properly implemented, will allow for the delay of any estate taxes that may be due until the death of the second spouse. In that circumstance, a second-to-die or survivorship policy can be a very good option.”
Other crucial considerations when folding a life insurance policy into an estate plan are the ownership and beneficiary details. Choices made at this stage can have major consequences when it comes time to implement the plan.
“There are three parties involved in a life insurance policy: the insured, the owner and the beneficiary. The dynamics between these three parties can be particularly impactful,” Werley said. “This is an area that has to be discussed and reassessed regularly. The owner and beneficiary of a policy can be changed once it is in force, but the insured generally cannot, so deciding which life to insure should be done with care.”
If using a life insurance policy as a buffer against estate taxes or other expenses, one should carefully consider exactly how the policy itself is handled, as different setups can trigger different tax repercussions.
“When using a life insurance policy for estate planning, the insured should consider having a trust own the policy,” Prather said. “Using an irrevocable life insurance trust, or an ILIT as it is commonly called, will allow for the life insurance proceeds to pass outside of the insured’s taxable estate and not be added back to the value of the estate. This also can help protect the insurance proceeds, and any other assets in the trust, from any claims from creditors of the trust beneficiaries. These trusts can be created to have very long durations to help maintain a family’s wealth from generation to generation.”
An irrevocable trust is usually a good idea when dealing with a large amount of life insurance, Prather added, though the best course of action will still depend on the individual.
“In some situations, creating a trust may not be practical or necessary,” he said. “In those situations, we just want to be sure that the insured understands that the proceeds will be paid directly to the policy beneficiary. We also want to make sure that none of the beneficiaries named on a policy are minors, as that would create the need for additional legal procedures.”
Regardless of the nuts and bolts of the policy, both Werley and Prather urged starting the process early to get ahead of any complications.
“Oftentimes, using life insurance as a risk mitigation strategy will come before the establishment of the long-term estate plan,” Werley said. “The key, therefore, is to make sure that the initial establishment of life insurance is done with the future in mind. Too often, life insurance is sourced to solve an immediate short-term problem, and it’s not given the flexibility to be able to pivot as life evolves.”
While it is beneficial to put a plan in place as soon as possible, life insurance policies are not something to set on a shelf and forget. Just as individuals’ wealth will fluctuate over the course of their lives, so too can the policies that make the most sense for an estate plan.
“Unfortunately, many life insurance policies are sold, and then they are not ever looked at again. This is the fault of the person that sold the policy,” Prather said. “Permanent life insurance policies are frequently based upon certain assumptions regarding premium payments and the timing of those payments, as well as the interest rate or dividend rate being credited to the policy. Any variation in these assumptions can have a negative and potentially very costly impact on a policy, possibly even causing a policy to fail.
“We review all the policies we have sold each year to make sure they remain on track, and we can adjust if needed. We also review many policies that we did not sell if requested to do so. Every person that has purchased a permanent life insurance policy should have that policy reviewed by an insurance professional to make sure that it is not in some type of distress. It is also important to review the policy and make sure that it is still the best type of policy for that individual’s circumstances.”
Since the insured won’t be around after the fact to clear up any uncertainties, it pays to have professionals involved on the front end who can highlight areas of concern and aid in tying up loose ends.
“Any estate planning conversation will center around three things: the people involved, the assets involved and the desired outcome,” Werley said. “You should have a clear picture of what you want to have happen when you die. Do you want to distribute assets to relatives unequally? Do you want to give to charity? Do you want any specific assets to be given special purpose? These types of questions should be thought through before you sit down with an estate planner, even if you don’t know the specific mechanisms to make them happen.”
Prather recommended working with an insurance advisor who has access to and works with many different carriers. This increases the chances of finding the best possible policy for one’s needs, since different carriers will vary widely in offerings and pricing. Estate planning is designed to provide peace of mind; any financial advisor worth the time and money will work to ensure the best possible outcome for everyone involved.
“We manage and service in excess of $2.5 billion of in-force life insurance for our clients,” Prather said. “I truly love the industry and believe in what life insurance provides for our clients and their families. I have seen many times how important and powerful an asset life insurance is to a family, whether that is a very wealthy family or not.”
Bottom line: You can’t take it with you, so do everyone a favor and figure out who’ll take it from you.
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