There are many reasons to put together an estate. One of the main reasons for those who already have grown children is to ensure that their assets are divided and distributed equally among all the heirs. Adding a life insurance policy to your estate planning can help in a variety of ways.
What to Know First
One huge myth in purchasing a life insurance policy is that the best thing to do is to name your estate as the beneficiary of your life insurance benefit. This is not wise. If you list your estate as the beneficiary, then the proceeds of your life insurance policy will first have to go through probate. The probate process can be a long one – taking months and even years to finish. Courts put estates through probate to ensure that the will left by the deceased is valid. While your estate is in probate your heirs will not be able to access any of the money paid out by your life insurance policy. This could be a problem, especially if the family was counting on using some of those funds to pay for your funeral expenses and immediate debt.
Furthermore, if the proceeds to your life insurance policy are added to your estate, that would only increase the value of your total estate. This could make your estate taxable. Check with your financial advisor as to the tax laws pertaining to estates in your particular location. Some states require that estates be taxed if the value is more than $1.5 million. Estate tax rates are upward to 48%, with California being one of the highest rates. Clearly, it is best to name specific heirs to receive the payout of your life insurance policy.
How Life Insurance Can Help with Planning your Estate
There are a couple of ways in which buying a life insurance policy can help with estate planning. First, a life insurance policy will help reduce or eliminate gift and estate taxes. For example, if you have a large estate and own multiple properties you might decide to bequest a summer home in the Hamptons to your son. Whether the bequest is property or other non-liquid items such as artwork or jewelry, the recipient is required to pay a gift or estate tax on the item. By taking out a life insurance policy, the funds can be used to offset those taxes. That would make your gift to your son truly a gift since he could own it outright, without the worry of having to pay an unexpected sum for the inheritance. The funds could also cover the various administrative costs associated with estates.
A second use for life insurance in estate planning is for junior generations to protect against having inheritances, such as residences, from being dragged back into an estate after it has already been passed down via a Qualified Personal Residence Trust (QPRT). QPRT抯 are put together by a member of a family抯 senior generation. The senior transfers a residence to the next generation. If the senior outlives the specified term of the QPRT then the residence eventually passes to the junior generation without any additional gift tax. However, if the grantor dies before the specified term, the residence is subject to being brought back into the estate. So, having the life insurance policy helps guard against that by enabling the junior generation to buy the residence outright should the grantor unexpectedly pass away.
There are many more ways in which life insurance can be used to solve issues associated with estate and gift taxes. It is best to consult a professional to help you determine which planning techniques are appropriate for your situation.
