The Role of Insurance in Estate Planning

Estate planning deals with the management and distribution of your assets when you die. Life insurance is a useful tool in these efforts.

It can protect your Estate from creditors, who may otherwise come after your assets in probate court. It can also help equalize your estate inheritance among heirs.

1. Protection

One of the primary goals of estate planning is to protect your family and provide for future generations. Life insurance can help in this regard by offering a variety of financial benefits.

For example, a policy’s death benefit can be used to pay for funeral expenses and debts, and it is generally exempt from income tax upon death. Additionally, life insurance proceeds can be used to pay estate taxes.

This can be especially helpful for families with multiple heirs, as it can help equalize distribution of assets. Life insurance can also be used in conjunction with a buy-sell agreement to ensure the continuity of a business after a key partner’s death.

For those who wish to leave a legacy, life insurance can be used as the basis for charitable trusts. An irrevocable life insurance trust (ILIT) can be used to control a term or permanent life insurance policy while the owner is still alive, and it can avoid income tax on the policy’s value.

2. Liquidity

Liquidity is the ease with which an asset or security can be sold. For business, liquid assets are those that can be converted into cash quickly to pay off debt or invest in growth opportunities. This can include treasury bills, drafts and commercial paper, among other interest-earning financial investments.

When it comes to estate planning, liquidity is important because family members need the proceeds of your death to pay taxes, funeral expenses and settle any outstanding debts. Life insurance policies help alleviate this burden by providing funds that are free of federal estate taxes.

Liquidity planning involves coordinating expected bills coming in and invoices that will be sent out through accounts payable and accounts receivable. It can also involve performing acid test ratios and quick and cash ratios to examine the financial health of your company. These ratios compare your most liquid assets with your current liabilities. The higher the ratio, the more financially healthy your company is.

3. Inheritance

Inheritance includes property or assets that are passed on to family members after a person’s death. It can include money, land or even shares. In inheritance planning, life insurance is useful to settle outstanding debts and pay estate taxes.

The determinants of material inheritance are complex, and it can be difficult to understand the motivations of donors and heirs. One hypothesis is that donors act out of altruism or exchange, where they are passing on their assets in order to facilitate the living standards of heirs, without any form of compensation.

This model may be true, but it is also likely that other factors are at play. Heirs, on the other hand, can be influenced by their own needs and desires, where equality in distribution is not always a priority. This can lead to tensions between donors and heirs. Having an irrevocable life insurance trust (ILIT) can be an effective way to avoid such issues.

4. Taxes

Proper estate planning allows you to manage your assets while alive and lay out how you would like them distributed upon death or incapacity. However, due to tax law changes, it is important to revisit your estate plan regularly.

The newest change in tax laws has dramatically changed how estates are handled. If you have assets in your estate that are subject to federal estate taxes, a properly drafted irrevocable life insurance trust (ILIT) can help protect these assets from this tax burden.

Additionally, a life insurance policy’s death benefit is a liquid asset and can be paid out to beneficiaries promptly. This can help equalize an estate inheritance between multiple heirs. For example, a mother might want to leave her beach house to both daughters and sons, but one daughter might live far away. Adding the life insurance death benefit to the estate can compensate this daughter and eliminate a potential family rift. It can also help pay any debts or expenses owed by the estate.