Life insurance policies guarantee financial protection in the event of an early or unexpected death. However, purchasing coverage can have benefits beyond peace of mind. With the right approach, life insurance policies can be leveraged to leave significant wealth to your heirs—wealth largely beyond the reach of creditors, and wealth that can be transferred to beneficiaries without having to go through probate.
Read more to learn how to integrate life insurance into your Estate Plan, or contact Ross & Shoalmire to speak to a Texarkana Estate Planning Lawyer and schedule your initial consultation.
The Different Types of Life Insurance
Life insurance is a financial product. In exchange for the policyholder making payments on a premium, the insurance company agrees to pay a sum of money to a named beneficiary upon the policyholder’s death. Most people use coverage to protect their family’s financial security, though some policies can also offer living benefits.
Life insurance policies typically fall into two separate categories:
- Term life insurance, which provides coverage for a set number of years. If you purchase this type of life insurance policy, you’ll usually be able to choose the “term” or duration of your coverage. Your beneficiaries will only receive death benefits if you pass away while your policy is still in effect.
- Permanent life insurance, which gives coverage for the entirety of your life—provided that you keep making payments on your premium and don’t voluntarily surrender your policy.
In general, term life insurance is much more affordable than permanent life insurance. This is due, in part, to the fact that most term life insurance policies accrue no cash value and are often never used. In contrast, permanent life insurance tends to accrue cash value over time, staying in effect until it is either canceled or the policyholder passes away.
The Advantages of Adding Life Insurance to Your Estate Plan
Adding life insurance to your estate plan gives you the opportunity to ensure that your loved ones receive financial support after your death. However, life insurance policies can be strategically employed to mitigate the many risks inherent to inheritance and succession.
Some of the most common uses for life insurance in estate planning include, but are not limited to, the following:
Leaving an Equal Inheritance for All Your Heirs
Estates come in all shapes and sizes. If yours contains complex or high-value assets, making big decisions about inheritance can very quickly become very complicated—especially if you aren’t sure how to divide them between your heirs without instigating conflict.
Life insurance policies can be used to avert conflict by offsetting an heir’s asset-based inheritance with a death benefits- and cash value-based inheritance.
Taking Care of Loved Ones with Special Needs
If one of your heirs cannot meet their basic needs without assistance, you may not be able to provide a lifetime’s worth of protection without taking much-needed assets from your other estate beneficiaries.
Life insurance can sometimes provide a fair compromise: as long as you stay current on your premium, your policy will pay a significant amount to an heir with disabilities. Meanwhile, your other heirs will still be able to receive their share of your remaining estate assets.
However, if you live in Texas or Arkansas, you need to exercise caution when leaving cash or high-value assets behind to an heir with special needs. Unless you take proactive steps, like establishing a special needs trust, a sudden windfall could come at the cost of your heir’s government benefits.
Defending Your Estate Against Federal Taxation
Texas and Arkansas won’t tax your heirs’ inheritance, but the Internal Revenue Service will try taking a cut if your estate’s value exceeds $13.99 million. Estates beyond this threshold are subject to a graduated tax rate of up to 40% of the estate’s total value. These taxes sometimes amount to millions of dollars—all of which must be paid within nine months of death.
Life insurance policies can be used to manage taxation-related risk if you direct your death benefits to cover all or a portion of an anticipated estate tax payment.
Using Your Estate Plan to Get the Most Out of a Life Insurance Policy
If you expect your estate to be large, complex, or subject to dispute, purchasing a large life insurance policy can add to its value—potentially increasing your estate tax liability or provoking conflict among your heirs. However, naming a trust as your policy beneficiary could negate these risks, putting your insurance benefits to good use without placing a greater burden on your loved ones.
In general, establishing a trust lets you:
- Separate your trust assets from your estate assets
- Condition and control the distribution of your beneficiaries’ inheritances
- Maintain your family’s privacy by keeping inheritances out of court
- Protect your life’s work from creditor claims and other probate contests
Combined with a life insurance policy, trusts can offer even more benefits. Some of the most popular ways to preserve life insurance benefits include:
Revocable Living Trusts
Revocable living trust can be used to manage a wide range of assets, such as:
- Your home
- Commercial real property
- Bank accounts and stock portfolios
- Jewelry and artwork
So long as you’re alive, a revocable living trust can be changed, amended, or terminated at any point. During your lifetime, you retain the right to use your trust assets as you see fit. Upon your death, a designated successor trustee will administer your estate in accordance with your instructions and in the best interest of your beneficiaries.
Life insurance policies can be used to fund a trust, both by paying for its long-term administration and by offering additional estate liquidity for heirs.
Irrevocable Life Insurance Trusts
An irrevocable life insurance trust, or ILIT, involves transferring an existing life insurance policy to the trust. Sometimes, the ILIT may purchase its own policy and make premium payments.
Since ILITs are irrevocable, they cannot be easily changed or terminated. Although this may seem like a downside, it often serves as an advantage: trusts don’t die, and any assets under their control will typically be spared from probate.
Special Needs Trusts
A special needs trust is a trust designed to provide maintenance to an heir with disabilities without risking critical government benefits. Any funds added to an eligible special needs trust won’t count toward Medicaid income limits and can be used for a variety of costs, including, but not limited to, the following:
- Medical expenses
- Education
- Recreation
- Transportation
- Home care
Different types of special needs trusts serve different purposes. Some, like first-party special needs trusts, usually require a Medicaid repayment provision. This provision stipulates that, when your named beneficiary passes away, any remaining funds must be used to repay Medicaid for the cost of benefits provided. Others, including trusts established by a parent, guardian, or other loved one, do not typically have a mandatory repayment provision.
