Life Insurance for Estate Planning

In addition to a will, life insurance can be an important part of your estate planning. The life insurance payout to your beneficiaries not only protects them financially, but also can alleviate the burden of paying a hefty estate tax, which in some cases can be upwards of 46%.

The estate tax is primarily a concern for those with an estate in excess of $2 million. Purchasing a life insurance policy as part of your estate planning will help to pay the associated taxes. To fully realize the payout from a life insurance policy, the executor of your estate or a beneficiary should be the owner.

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Understanding Estate Taxes

The Economic Growth and Tax Relief Reconciliation Act of 2001 developed a tax repeal schedule to ensure that the estate tax would be reduced over a number of years, and by 2010, would be repealed. According to the article “Shifting Life Insurance Ownership,” an (Investopedia website):

“In 2006, the federal estate tax exclusion amount increased to $2 million per person. This will be in effect until 2009, when the amount will increase again -- to $3.5 million. In 2010, there will be no federal estate tax, but for all years after that, the exclusion amount will be reset to $1 million per person. This means that if your taxable estate exceeds $2 million, you will most likely be subject to estate taxes; these taxes can be as high as 46%, but this rate will fall to 45% in 2007, where it will remain until 2009... After its expiration, the exclusion amount will be $1 million and the highest rate will be 55%, assuming no further changes are made.”

Life Insurance as Part of Estate Planning

If you anticipate your assets will be over $2 million, a life insurance policy should be part of your estate planning. Otherwise, your beneficiaries will be facing a hefty estate tax. By either transferring ownership of your life insurance policy or putting the policy into an irrevocable trust, you will be able to provide your beneficiaries with tax-free proceeds following your death.

• Transferring ownership – by transferring ownership, the policy no longer belongs to you, so it will not be included in your estate
• Creating an irrevocable life insurance trust – ownership of your policy is with a trustee, therefore it does not belong to you and will not be included in the estate

In both of these scenarios, you will give up legal rights of ownership to make changes to beneficiaries, premium payments, cancel the policy or borrow against the cash value.

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