What Role Does Life Insurance Play in Estate Plan Tax Strategies?
EstateTaxes.net
What Role Does Life Insurance Play in Estate Plan Tax Strategies?
In the intricate dance of estate planning and tax strategy, life insurance often takes center stage, as explained by a Principal & Financial Planner. Alongside industry professionals, we've gathered additional answers that highlight its pivotal role in various scenarios. From mitigating estate taxes to ensuring business continuity, these insights demonstrate the multifaceted importance of life insurance in estate planning.
- Life Insurance for Estate Taxes
- ILIT Preserves Family Business
- International Estate Planning with ILIT
- Life Insurance Eases Estate Settlement
- Life Insurance Mitigates Estate Taxes
- Funding Trusts with Life Insurance
- Equalizing Inheritance with Life Insurance
- Securing Business Continuity with Life Insurance
Life Insurance for Estate Taxes
The estate tax threshold is currently $13.61 million per individual, meaning that life insurance for the sole purpose of covering estate taxes only applies to the very top 0.1%. The top 1% of net worth is $5.81 million. So, 99.9% of people don't need to worry about estate taxes. Also, assets such as stocks, bonds, and real estate receive a step-up in cost basis at death. This means you won't owe taxes on those items either. However, for the very top 0.1% of families worried about estate taxes, you should consider a whole life insurance policy to help your heirs pay for any estate taxes. This is fairly simple math to do and can assist in allowing them to hold on to illiquid assets such as farmland or a private business, instead of being forced to sell these assets to cover the tax.
However, the priority should be moving the assets out of your estate before death with
1. Family gifts of up to $18,000 per person
2. Consider a Dynasty 529 plan (I've written more about this on my website https://www.flatfee-financial.com)
3. Donor Advised Funds if you are charitably inclined
4. Transferring business assets to family
Beware of the generation-skipping transfer tax if you are moving assets between generations and always work with a financial or tax professional when pursuing a strategy like this.
ILIT Preserves Family Business
Let me share a real-world example. I once worked with a client who owned a successful family business worth about $10 million. They were worried about estate taxes eating up their children's inheritance. So, we set up an irrevocable life insurance trust (ILIT) with a $5 million policy. This strategy was brilliant because the death benefit wasn't part of the taxable estate. When the client passed away, the trust paid out tax-free, covering the estate tax bill without touching the business assets. It's a classic move that saved the family millions and kept the business intact for the next generation.
International Estate Planning with ILIT
I worked with a couple whose estate was valued at approximately $65 million. They needed estate planning to minimize the tax burden on their children, and here is what we did. Effective estate planning is crucial for preserving wealth across generations.
To start, I would like to give you some background. The husband and wife are originally from Switzerland, where they owned multiple properties valued at over $60 million. They moved to the U.S. and became U.S. citizens. At one point, one of them expressed regret about becoming U.S. citizens because now their worldwide assets would be part of their estate and taxable upon their death. This unexpected tax implication highlighted the complexities of international estate planning.
We examined their projected tax obligations and calculated that a $20 million second-to-die policy would make the most sense for them. A second-to-die policy is a type of insurance that pays out after the death of the second spouse and is often used as an estate planning tool. This strategy provides liquidity when it is most needed, allowing heirs to cover estate taxes without liquidating valuable assets.
Having this death benefit in place ensures that the couple’s children will be able to maintain most, if not all, of the assets and will not have to sell a portion of the estate just to pay the taxes due. This approach not only preserves the family's legacy but also ensures financial stability for future generations.
The couple created an ILIT (Irrevocable Life Insurance Trust) and applied for the policy. This is a key step, as it is important to create and fund the trust first and then apply for the life insurance. If done the other way around, the policy, even if owned by the trust, will be part of their estate for three years and create more tax obligations. The careful timing and structuring of these actions are critical to maximizing the benefits of estate planning tools.
When it comes to estate planning, it is important to have a team that works together. In this couple’s case, they were dual citizens and had to work with a financial professional proficient in international tax law and a life insurance agency specializing in coverage for foreign nationals.
Life Insurance Eases Estate Settlement
Life insurance serves as a vital tool in estate planning primarily due to its ability to provide immediate access to cash without tax obligations when an individual passes away. This is indispensable because it can prevent the need to hastily sell off assets from the estate to cover any costs associated with the deceased's final expenses. The beneficiaries can use the insurance funds to pay for things like funeral costs or outstanding debts, ensuring that the estate's value is not diminished unnecessarily by taxes.
Moreover, this financial relief can also provide a buffer during the period when the estate is being settled, which can sometimes take a significant amount of time. To understand how life insurance can bolster your estate plan, consider speaking with a financial advisor today.
Life Insurance Mitigates Estate Taxes
When a person passes away, their estate may be subject to various taxes which can considerably reduce the amount passed on to their heirs. Life insurance can be strategically used to cover these estate taxes directly. This is incredibly advantageous because it means the family won't need to sell property or other valuable assets in a rush, which might result in them receiving less than the assets are worth due to the urgency.
By utilizing the insurance proceeds for tax payments, the value of the estate can be preserved for the beneficiaries as intended. If you're considering ways to mitigate estate taxes, exploring life insurance options can be a valuable step to take.
Funding Trusts with Life Insurance
Incorporating life insurance into an estate plan can also be an efficient method to fund trusts, which may be part of a strategy to bypass the sometimes costly and public process of probate. Assets in a trust often avoid probate taxes and can be directed to the chosen beneficiaries with increased privacy and speed. Having life insurance proceeds go directly into a trust can streamline the transfer of wealth and simplify the distribution process.
This strategy also provides more control over how assets are used by heirs, potentially protecting the wealth from their creditors. To implement this strategy effectively, it's wise to consult with an estate planning professional.
Equalizing Inheritance with Life Insurance
Life insurance payouts are often used to equalize inheritance among heirs when there is a concern about an uneven distribution of assets. For example, if the majority of an estate's value is tied up in a business or property, some heirs may end up with non-liquid assets and hence face challenges when trying to realize the asset's value. A life insurance policy can offer liquid funds to balance out the inheritances, ensuring that each heir receives a fair share of the estate without having to sell valued assets.
This can prevent familial disputes and promote harmony among beneficiaries. Looking into how life insurance can balance inheritances is a thoughtful approach to fair estate planning.
Securing Business Continuity with Life Insurance
For business owners, life insurance plays a pivotal role in ensuring the continuity of the business after their passing. It is often used in buy-sell agreements, which are arrangements that allow remaining business partners to buy the deceased's stake in the company. By using life insurance payouts, they can purchase the shares without the need to drain business resources, thereby stabilizing the business during the transition period.
This prevents the business from potentially having to be sold or dissolved due to lack of funds to buy out the deceased partner's interest. Business owners should engage in discussions with financial experts to understand how life insurance can secure the future of their business.