Your first answer if asked about the use and purpose of life insurance is to replace the income your family depends on if you die. A policy can do more, though, and can be an important element in your larger estate plan. Life insurance can provide income and a base for family wealth.
Learn about the types of life insurance policies available, what you have and may think about buying and give those policies a place in your estate plan.
Life Insurance Types
This policy is designed and well-suited to provide a large death benefit for the lowest premium possible. You select the "term" the policy covers, such as 5, 10 or 20 years, and pay premiums on a schedule, such as monthly or annually.
Your policy may include an option for you to extend the policy's coverage past the end of the term, but the rate and renewal term may differ. For example, you may be able to extend coverage on a yearly basis and the annual premium will likely be higher. You may want to use this feature type if your policy ends soon, but you want coverage for a while longer, such as until a child completes college.
Term life insurance is attractive because you can buy what you need. Maybe you only need to insure against your death for the next 10 years, due to your stage of life and financial situation. Rates can vary, so it's worth your while to shop and buy exactly what you need.
Whole life insurance offers a death benefit and an investment component. The policy stays in force as long as the premiums are paid, with the goal for the investment portion of the policy's value to cover the premiums. It's a permanent policy, intended to stay in force for your lifetime. Cash value in a whole life policy builds over time, and grows tax-deferred. Some policies allow the payment of a lump-sum premium, without further premium payments as long as the policy's cash value grows to cover that expense.
Another "permanent" life insurance type is a universal policy. Here, you're given options for how much and how often you pay premiums, and changes in the death benefit amount are possible.
Variable Life Policies
A variable life insurance policy is another whole life insurance type. The insured can make investment choices, and shares in the risk and reward of investments of premium dollars. Returns on the investment component of the policy can be more volatile. In contrast to a traditional whole life policy, features such as borrowing against policy cash value aren't available.
Ownership of Policies, Benefit Payments and Settling Your Estate
An insurance policy has an owner, an insured and a beneficiary. A single person may have more than one role in a policy's parts. For example, you may own a policy on your life and your child is the beneficiary.
The death benefit payment is made to the beneficiary, and isn't part of your estate that is settled through a probate court. Probate is the process of settling a deceased person's affairs; most but not all property types pass through the probate process. Probate is often avoided due to the time and expense involved.
However, life insurance proceeds are often included in another important "estate" created at your death - your estate for federal and state estate and transfer tax purposes. If the value of a life insurance death benefit is added to your estate, there may be taxes to pay. Think you're not "rich" enough to worry about it? Assets such as high-value insurance policies and your home can make these taxes a real concern
Planning for Best Use of Your Insurance
No matter what policy type you choose, compared to the premium payment, life insurance can provide a sizeable return. The payout can provide a crucial pool of funds for a family that's lost a parent-breadwinner or provide the means to manage business concerns, such as buying out the shares of a deceased partner. Insurance proceeds can free up other assets and serve as a key element in your estate plan.
Fortunately, tax laws provide the means to avoid inclusion of life insurance benefits in your taxable estate through a life insurance trust or transferring ownership of your policy to someone else. Essentially, if you don't own or have control over a policy, you won't own it for estate tax purposes.
An estate planning attorney can help you set up insurance trusts or arrange changing ownership of your policies. Meeting tax law requirements can be complex, so seeking professional help is usually the best option.
Moving forward, you can still provide premiums payments through annual gifts, and there's no tax impact if the amount falls within the annual exclusion amount. Gifts under the annual exclusion amount aren't taxed, and there's no limit on the number of donees you can give gifts to. The annual exclusion for 2009 was set at $13,000.
Questions for Your Attorney
- I own life insurance policies on my life, and I usually buy life insurance through work, too. I know I might not always have coverage through my work, but does the possible death benefit change my estate plan at all?
- How does life insurance factor into my estate plan if I'm a small business owner?
- Are there any differences in the limits on how much insurance I can buy on my life compared to other possible owners, such as my spouse or business partners?