Life Insurance in Estate Planning
May 28, 2013
We are all aware of one of the most basic purposes for obtaining life insurance–to provide families, relatives, and/or close friends with financial support in the event that a person passes away. However, life insurance also serves other important purposes and can be used in a variety of ways in estate planning.
Irrevocable Life Insurance Trusts (ILIT)
An ILIT is a trust that allows life insurance to be excluded from the value of an estate and ultimately reduces estate taxes. One of the primary purposes of an ILIT is that is provides liquidity to pay any estate taxes that are owed on an estate. For example, if an estate owes estate taxes, instead of liquidating assets of the estate to pay for those taxes, an ILIT allows for insurance proceeds to pay any estate taxes.
There are specific requirements to exclude life insurance from an estate. These requirements include the settlor giving up control of the trust to neutral trustee and not retaining any incidents of ownership over the life insurance policy. If the requirements are not met, then the life insurance proceeds could be included in the estate and defeat the purpose of the ILIT.
Buy-Sell Agreements for Businesses
Life insurance can also be useful in a business setting when owners of a business pass away. For example, owners of a business can take out a life insurance policy on their lives and make the other owners beneficiaries, so that the other owners can have the funds to purchase the deceased owner’s interests in the business. This is typically done through a buy-sell agreement. A buy-sell agreement will specify how the deceased owner’s interest in the company will be purchased and what type of life insurance will be used. In some scenarios each owner might obtain a policy on the life of the other owners, or the entity itself could obtain a life insurance policy on the lives of the owners. Either way, life insurance can effectively be used to provide liquidity to purchase the interests of deceased owners.
Purchasing Beneficiary Shares
Life insurance can also be useful for the beneficiaries of an estate. For example, if there are four children of an estate entitled to an asset but only three of them want to inherit that asset, then the settlor can purchase a life insurance policy and make the other child a beneficiary of that policy, so that child can still have an equal share in the estate, but not have to inherit the undesired asset. In this scenario, the life insurance serves a tool to buy out beneficiaries’ interests in an assets that they do not want to inherit.
These are only some of the ways that life insurance can be used in estate planning. The use of life insurance also requires care to ensure that the proceeds go to the right beneficiaries and otherwise accomplishes the goals of estate and business planning. Morris Estate Planning attorneys have years of experience working with clients and their businesses to make sure they are structured correctly. If you have questions about life insurance and how it should be used as part of your estate plan, please contact us.