Life insurance can play an important role in an estate plan by providing financial resources for the people who depend on you and helping support broader planning goals. The right approach depends on several factors, including your coverage amount, policy type, ownership structure, beneficiary designations, tax position, and long-term objectives.

Because life insurance can affect both income tax and estate tax planning, it should be reviewed alongside your broader estate plan, not as a stand-alone decision. According to the Internal Revenue Service (IRS), life insurance proceeds paid because of the insured person’s death are generally excluded from gross income, but policy proceeds may still be included in the taxable estate depending on ownership and beneficiary structure.

Determine How Much Coverage You Need

There’s no universal formula for calculating the appropriate amount of life insurance. Your needs depend on your income, debts, family responsibilities, assets, and long-term objectives. Begin by estimating the financial obligations that might remain after your death. These may include:

• • Funeral and other final expenses
  • Mortgage balances and other debts
  • Income replacement for a surviving spouse or partner
  • Childcare and education costs
  • Support for a dependent with special needs
  • A desired inheritance or charitable gift

 
Next, subtract resources available to meet those obligations, such as savings, investments, retirement benefits, and existing insurance policies. The difference can provide a starting point for determining how much additional coverage you need.

Note: Don’t assume employer-provided insurance is sufficient. Group coverage is often limited to a multiple of salary and may end when you leave your job.

Select Coverage That Matches Your Objectives

Term life insurance generally provides coverage for a specified period and may be appropriate for temporary needs, such as replacing income during your working years or paying off a mortgage. It typically costs less initially than permanent coverage.

Permanent insurance, such as whole life and universal life, is designed to remain in force for life as long as the required premiums are paid. It may also accumulate cash value. This type of policy can be useful when the need for coverage is expected to continue indefinitely, such as providing estate liquidity, supporting a lifelong dependent, or funding a legacy.

Affordability matters. A policy offers little protection if rising premiums or changing circumstances may make it difficult to keep the coverage in force. Review policy guarantees, projected values, fees, and premium requirements carefully before you buy.

Coordinating Life Insurance & State Planning

Life insurance can replace income, equalize assets among children active and inactive in a family business, provide cash to pay estate tax, or serve as a vehicle for passing leveraged funds free of estate tax.

Policy proceeds generally aren’t subject to income tax, but if you own the policy, the proceeds will be included in your taxable estate. If your estate is large enough that estate taxes are a concern, some or all the proceeds could be subject to estate tax.

Ownership depends on several factors, including who has the right to name the beneficiaries of the proceeds. Generally, to reap potential tax benefits, you must sacrifice some control and flexibility as well as some ease and cost of administration.

Determining who should own the life insurance policy is a complex task because there are many possible owners, including you or your spouse, your children, your business, or an irrevocable life insurance trust (ILIT).

An ILIT can own one or more policies on your life, and it manages and distributes policy proceeds according to the terms you establish when you set up the trust. The trust keeps insurance proceeds, which could otherwise be subject to estate tax, out of your estate (and possibly your spouse’s). You can’t retain any power over the policy, such as the right to change the beneficiary. The trust can be designed to make a loan to your estate to meet liquidity needs, such as paying estate tax.

To choose the appropriate owner, consider why you want the insurance, such as to replace income, to provide liquidity or to transfer wealth to your heirs. You must also determine the importance of tax implications, control, flexibility, and ease and cost of administration.

Review Your Coverage

Is your life insurance aligned with your estate plan? Reviewing your policy now can help you identify coverage gaps, liquidity needs, and planning opportunities. Contact us to discuss your estate plan.