What Role Does Life Insurance Play in Estate Tax Planning?

What Role Does Life Insurance Play in Estate Tax Planning?

Life insurance is important for many reasons, but in the confusing field of tax planning, it can be easy to overlook. We've gathered insights from top professionals in the insurance field to illuminate the pivotal role of life insurance in estate tax planning. From preserving family farms to safeguarding an estate's value, here are four compelling scenarios shared by a CEO and several licensed insurance agents that prove the value of maintaining a suitable life insurance policy.

• Life Insurance Preserves Family Farms
• Grandfather's Legacy Through Life Insurance
• ILIT Manages Estate Taxes
• Life Insurance Safeguards Estate Value

Life Insurance Preserves Family Farms

Taxes can devastate an estate. In some cases, where the estate will be liquidated, the estate tax, while not pleasant, is what it is. However, in some situations, like, for example, when a family wants to keep a farm in the family, estate taxes can destroy that possibility.

Farmers who bought their land over the past six or seven decades may have paid $500 an acre or less. Suddenly, land is far more valuable than it ever has been. Even though farmers aren't making a lot of money every year, their land value makes them seem "rich" to the government.

Children who want to continue farming the land often aren't able to, because they have to sell the farm to pay the taxes. That's where life insurance can make a huge difference. Life insurance settlements aren't taxable, but they can be used to pay estate taxes. If you have a life insurance policy that is high enough to cover the taxes due on an estate, you can plan to keep that estate in your family, and won't risk essentially losing it to the government.

Grandfather's Legacy Through Life Insurance

One of my best friends’ dad had four grandchildren, of whom he thought the world, so in his estate, he had four $50,000 death benefit whole life insurance policies. About six years before the policies would have been paid up, he passed away. Each of the policies had one of the four grandchildren named as beneficiary, and if they were a minor, had a co-beneficiary named—the executor of the estate—until they were of legal age.

At the time of passing, the youngest grandchild was 20 years old. Each policy had a note: “To help get you started in this great life, pay it forward.” We all know life insurance proceeds are tax-free/non-taxable, and two of the four grandchildren used the money to set up an IRA and an annuity for their future.

ILIT Manages Estate Taxes

In one case, a client used an irrevocable life insurance trust (ILIT) to manage estate taxes. By transferring their life insurance policy to the ILIT, they ensured the death benefit was excluded from their taxable estate. This move saved their heirs from a significant tax burden. This strategy provided cash to pay estate taxes without selling valuable assets. It helped preserve the family's wealth, and meet their financial goals.

Life Insurance Safeguards Estate Value

Life insurance can be a vital tool in estate tax planning, offering a strategic way to manage financial obligations that arise after one’s death. Let's consider a realistic scenario involving a client.

This client, 55, has built a substantial estate valued at $15 million, including investments, real estate, and a family business. With federal estate taxes applied to estates over $12.06 million (as per the 2022 IRS threshold), the client faces significant potential estate taxes, that could greatly reduce the inheritance meant for his beneficiaries.

To address this, they purchase a permanent life insurance policy with a $5 million death benefit. The annual premium for this policy is about $70,000, and it is designed to ensure the proceeds are payable directly to an irrevocable life insurance trust (ILIT), keeping them out of the taxable estate.

When this client passes away, the trust receives $5 million, tax-free, from the life insurance policy. These funds cover estate taxes, legal fees, and other related expenses, without needing to liquidate any estate assets. This strategy preserves the estate’s value, ensuring that Alex’s real estate holdings and family business can be passed on to his heirs, without a forced sale to meet tax obligations.

In this example, life insurance provides a liquidity solution and safeguards the estate’s value, ensuring Alex’s financial planning benefits his family as intended. This approach highlights the powerful role life insurance can play in comprehensive estate tax planning.