Life insurance can be a powerful estate planning tool for nontaxable estates

For years, life insurance has played a critical role in estate planning, providing a source of liquidity to pay estate taxes and other expenses. It’s been particularly valuable for business owners, whose families might not have the liquid assets they need to pay estate taxes without selling the business.

Under the Tax Cuts and Jobs Act, the estate tax exemption has climbed to an inflation-adjusted $10 million per person through 2025 (projected to be just over $11 million per person for 2018). Even before the increase, federal estate taxes weren’t a concern for the vast majority of families, and now even fewer families are at risk. But even for nontaxable estates, life insurance continues to offer significant estate planning benefits.

Replacing income and wealth

If you die unexpectedly, life insurance can protect your family by replacing your lost income. It can also be used to replace wealth in a variety of contexts. For example, suppose you own highly appreciated real estate or other assets and wish to dispose of them without generating current capital gains tax liability. One option is to contribute the assets to a charitable remainder trust (CRT).

As a tax-exempt entity, the CRT can sell the assets and reinvest the proceeds without triggering capital gains tax. In addition, you can enjoy an income stream and charitable income tax deductions. Typically, distributions you receive from the CRT are treated as a combination of ordinary taxable income, capital gains, tax-exempt income and tax-free return of principal.

After the end of the CRT’s term (which can be a specific number of years, your lifetime or even the joint lifetimes of you and your spouse), the remaining trust assets pass to charity, reducing the amount of wealth available to your children or other heirs. But you can use life insurance to replace that lost wealth.

You can also use life insurance to replace wealth that’s lost to long term care (LTC) expenses, such as nursing home costs. Although LTC insurance is available, it can be expensive, especially if you’re already beyond retirement age.

For many people, a better option is to use personal savings and investments to fund their LTC needs and to purchase life insurance to replace the money that’s spent on such care. One advantage of this approach is that, if you don’t need LTC, your heirs will enjoy a windfall.

Finding the right policy

These are just a few examples of the many benefits provided by life insurance. We can help you determine which type of life insurance policy is right for your situation and assist in finding the right insurance agent for you.

© 2018

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Who should own your life insurance policy?

If you own life insurance policies at your death, the proceeds will be included in your taxable estate. Ownership is usually determined by several factors, including who has the right to name the beneficiaries of the proceeds. The way around this problem is to not own the policies when you die. However, don’t automatically rule out your ownership either.

And it’s important to keep in mind the current uncertain future of the estate tax. If the estate tax is repealed (or if someone doesn’t have a large enough estate that estate taxes are a concern), then the inclusion of your policy in your estate is a nonissue. However, there may be nontax reasons for not owning the policy yourself.

Plus and minuses of different owners

To choose the best owner, consider why you want the insurance. Do you want to replace income? Provide liquidity? Or transfer wealth to your heirs? And how important are tax implications, flexibility, control, and cost and ease of administration? Let’s take a closer look at four types of owners:

  1. You or your spouse. There are several nontax benefits to your ownership, primarily relating to flexibility and control. The biggest drawback is estate tax risk. Ownership by you or your spouse generally works best when your combined assets, including insurance, won’t place either of your estates into a taxable situation.
  2. Your children. Ownership by your children works best when your primary goal is to pass wealth to them. On the plus side, proceeds aren’t subject to estate tax on your or your spouse’s death, and your children receive all of the proceeds tax-free. On the minus side, policy proceeds are paid to your children outright. This may not be in accordance with your estate plan objectives and may be especially problematic if a child has creditor problems.
  3. Your business. Company ownership or sponsorship of insurance on your life can work well when you have cash flow concerns related to paying premiums. Company sponsorship can allow premiums to be paid in part or in whole by the business under a split-dollar arrangement. But if you’re the controlling shareholder of the company and the proceeds are payable to a beneficiary other than the business, the proceeds could be included in your estate for estate tax purposes.
  4. An ILIT. A properly structured irrevocable life insurance trust (ILIT) could save you estate taxes on any insurance proceeds. The trust owns the policy and pays the premiums. When you die, the proceeds pass into the trust and aren’t included in your estate. The trust can be structured to provide benefits to your surviving spouse and/or other beneficiaries.

Contact us with any questions.

© 2017

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