Life insurance can be a helpful tool in the overall financial and estate planning process, providing a source of immediate cash that can replace the income stream lost at death, cover costs of estate settlement, and provide a source of funds to pay debts, taxes, or accomplish the seamless transfer of a farm, ranch, or business interest—without requiring any other assets to be sold to obtain these funds. Life insurance can also help avoid federal estate taxes with careful planning.
If one child is to inherit a farm or ranch that is the family’s most valuable asset, for example, a life insurance policy could be used to provide funds to buy out the other children’s interest in the property, or to provide a source of funds to give those children directly, treating them equitably while leaving the ranch to the child who intends to operate it. This may be a necessary component of a plan that will avoid the need to sell all or a part of the property in order to equitably distribute assets among several children.
Life insurance comes in a variety of different types. The popular “whole life” insurance policy will provide a benefit on death for the entire life of the insured person, while a “term” life insurance policy is a cheaper option that offers protection only for a limited period of time, making it a popular choice to purchase during the insured person’s working years for income-replacement purposes to protect a family’s finances in case of an untimely death. Whole life policies often allow the insured to borrow against the value of the policy, with any outstanding loan amounts deducted from the benefit to be paid on death. Life insurance policies also designed to serve as vehicles for tax-deferred investment are available in a variety of different options matched to the insured’s tax and planning goals.
Life insurance also affords planning opportunities for charitable giving. You can name a charity as the beneficiary of your policy and continue paying the premiums, retaining your ability to access the policy’s cash value, or as a successor beneficiary in the event the primary beneficiary or beneficiaries are no longer living. Like designating a charity as a beneficiary in your will or living trust, this option preserves your ability to adapt to changed circumstances down the road. If you are sure you will no longer need the policy and wish to use the policy to leave a significant charitable gift, you may want to consider irrevocably assigning all or part of the policy to charity, entitling you to an immediate charitable income-tax deduction. You will also receive a charitable deduction for contributions made to the charity for payment of future premiums.
One option that can result in a significant gift to charity while still ensuring family members are taken care of is the use of a life insurance policy to “replace” the value of an asset given to charity. This policy is often purchased with the money saved from the income-tax deduction resulting from the original donation, allowing the donor to benefit charity while ensuring the gift to charity has minimal negative financial impact on the donor’s heirs. Some sophisticated estate planning techniques use this basic concept to help avoid estate taxes, by employing a combination of charitable and life insurance trusts to provide income to the donor during life, provide an inheritance for family members, and leave a significant gift to charity.
MSU Extension “Life Insurance: An Estate Planning Tool” (199211HR)