Estate Planning And Life Insurance — 5 Ways They Work Together

Although we do not sell life insurance here at Samuel, Sayward & Baler LLC, we do help clients plan for their families' future and life insurance is often a part of that planning. Here are five things to consider in the context of your estate plan when thinking about purchasing, or dropping, a life insurance policy.

1. Life insurance is an excellent planning tool for young families. Young couples just starting life together often do not have a lot of assets. They are at the beginning of their careers so their earnings are not at their peak. In addition, they may carry significant student loan debt or a large mortgage.

The birth of a child is often the event that motivates them to purchase life insurance so that if one of them passes away, the survivor will have sufficient funds to stay in the house and raise the children. Considerations such as the impact the loss of one spouse's income will have on the ability to pay the bills and educate the children should be analyzed when determining whether and how much life insurance to purchase.

2. Life insurance is taxable in the insured's estate (often). Many people are confused about the taxability of life insurance. In most cases, life insurance proceeds are not taxable income to the person who receives them. For example, if my aunt names me as the beneficiary of her $100,000 life insurance policy, that $100,000 is not taxable income to me.

However, life insurance proceeds are a taxable asset of the insured's estate if the insured owned the policy or had the right to cancel, surrender, or assign the policy or change the policy's beneficiary. As such, although I will not pay income tax on the $100,000 of life insurance proceeds my aunt left me, those proceeds will be included in my aunt's taxable estate and will increase the estate tax liability if my aunt's estate is large enough to require the payment of federal or state estate tax.

3. Life insurance can be an easy way to solve a hard problem. Life insurance can be a good way to address a situation that is creating stress in planning. For example, spouses in a second marriage who want to leave pre-marriage assets to children from a prior marriage but also want to take care of their spouse, could purchase life insurance payable to the surviving spouse while benefiting children with the pre-marital assets. Business owners who want to make sure their surviving partners have the capital to continue to run the business may purchase life insurance on each other or through the business.

Parents who want to keep a beloved vacation home in the family but realize the expense of maintaining the property will be a burden to their children can use life insurance to provide funds to pay the costs of maintaining the home following their deaths. Families with a special needs child who want to ensure that funds are available for the child's lifetime to provide for housing or other needs may use life insurance to fund a trust for the child.

4. Life insurance can be a good way to pay estate taxes. For those who have a taxable estate (i.e., more than $11.7 million federally in 2021 and $1 million in Massachusetts), life insurance can be a good way to provide liquidity to pay that tax which is due nine months after death. However, if the life insurance policy is owned by the deceased, then the life insurance proceeds are added to the taxable estate thereby increasing the estate tax liability.

Purchasing and owning life insurance in an irrevocable trust will prevent the life insurance proceeds from being part of the insured's taxable estate thereby preserving the full value of the insurance for the family. With speculation that Congress may reduce the estate tax exemption amount to $3.5 million and increase the rate of the federal estate tax, the irrevocable life insurance trust may become a more frequently used planning tool.

5. Review your life insurance on a regular basis. Life insurance is not an asset that should be purchased and then never looked at again. As time goes by, needs change and life insurance purchased 10 years ago may no longer be sufficient or may no longer be needed. So-called "term" life insurance means that the premiums for the policy are fixed during the term but the policy will expire or the premiums will increase significantly when the term ends.

Term policies can be an excellent way to address a short-term situation such as providing funds for children's education or paying off the mortgage. Once the children have graduated from college or the mortgage is paid, the purpose for which the insurance was purchased is no longer important. If the intention is that the insurance proceeds be available to support that vacation home you are leaving to your children or fund a trust for a special needs child, then a policy that will expire is probably not the right choice.

In my experience, life insurance is typically more complicated than it seems at first blush. It is advisable to work with an experienced life insurance agent, a financial planner, and an estate planning attorney to ensure that you purchase and retain insurance that meets your goals and is best suited for your needs, and own it in a way (in your name or in an irrevocable trust) that works with the rest of your estate plan.

Attorney Suzanne R. Saywardis a partner with the Dedham law firm of Samuel, Sayward & Baler LLC which focuses on advising its clients in the areas of estate planning, estate settlement and elder law matters. Sheis certified as an elder law attorney by the National Elder Law Foundation, a private organization whose standards for certification are not regulated by the Commonwealth of Massachusetts.This article is not intended to provide legal advice or create or imply an attorney-client relationship. No information contained herein is a substitute for a personal consultation with an attorney.For more information call 781-461-1020 or visitour website at http://ssbllc.com.