Estate planning is often perceived as a complex and intimidating task, but it is an essential process designed to distribute assets efficiently according to your wishes after your passing.
One tool that can play a pivotal role in estate planning, but that often gets overlooked – life insurance! Life insurance can help facilitate estate planning goals around wealth transfer, managing estate taxes, and providing financial security for successful families.
In this piece, we will explore the importance of life insurance in high net worth estate planning, examine the cost of liquidity inside versus outside of the estate, and discuss the planning benefits of sometimes having more than one type of policy to address different issues and needs.
At C3 Financial Partners, we work with clients and their advisors to identify and implement the right life insurance solutions to help support their estate planning goals.
Understanding Life Insurance in Estate Planning
Life insurance provides a death benefit that can serve several purposes in estate planning. These purposes include:
- Providing Liquidity
One of the primary benefits of life insurance is the liquidity it offers. Upon the policyholder’s death, the death benefit is typically paid out quickly, providing immediate cash flow to cover liabilities that may exist or arise, including estate taxes. This liquidity can be crucial, especially when the estate consists primarily of non-liquid assets such as real estate, businesses, or collectibles. - Equalizing Inheritances
A goal for many in their estate planning is avoiding strife amongst their heirs. Life insurance can help in this effort when it is used to balance inheritances among heirs. For example, if one child inherits a family business and another does not, a life insurance policy can provide a cash inheritance to the child not involved in the business, ensuring fairness and avoiding potential family disputes. - Paying Estate Taxes
Federal and State estate taxes can significantly reduce the value of an estate. Life insurance proceeds can be used to pay these taxes, preserving the estate’s assets for the heirs. - Funding Trusts
Life insurance can be used to fund various types of trusts, such as a revocable living trust or an irrevocable life insurance trust. These trusts can provide ongoing financial support to beneficiaries, manage assets for minor children, or support charitable causes.
At C3 Financial Partners, we work with clients and their advisors to help achieve clarity in the client’s estate planning goals and how life insurance may help achieve them.
The Cost of Liquidity Inside vs. Outside of the Estate
As noted, the benefits of life insurance in estate planning largely arise from the liquidity provided by the policies when it is most needed. Without the liquidity from life insurance, the deceased’s estate and heirs would have to turn to other sources to find the cash necessary to pay any liabilities.
For example, the federal estate tax is due 9 months after the date of death and must be paid in cash. Without the payment of a death benefit from a life insurance policy, the estate would need to find the cash elsewhere – potentially from the sale of investments or other assets, including a closely held or family-owned business, or by taking out a loan.
When incorporating life insurance into estate planning, it’s crucial to compare it with the costs and challenges of obtaining liquidity from other sources. With life insurance, the costs are the premiums paid during the existence of the policy and the death benefit is paid quickly after the death of the insured.
For other forms of liquidity, the estate may face some of the following challenges or costs:
- Selling assets, including investments and business interests, can trigger a taxable event and therefore require even more cash to be raised or that the amount of assets sold be greater to account for these taxes.
- If the estate consists of largely illiquid assets, it might prove difficult to dispose of them in the timeframe necessary to file an estate tax return and pay the related estate tax.
- The timing of the asset sale may not be ideal, and the estate will receive less for the assets than if the sale had occurred at a more opportune time.
- Obtaining a loan means that payments of both principal and interest will need to be made in the future, simply deferring, rather than eliminating, the need to find cash to pay the liability.
- Using cash that might already be available in the estate means there is less inheritance to pass along to heirs and other beneficiaries.
And those are just the financial costs. There is also the emotional cost of having to potentially sell assets that could have deep meaning to the heirs, such as a family business.
At C3 Financial Partners, we can show clients and advisors the benefits and drawbacks of various funding mechanisms for their estate planning, so they have confidence they are making the best choice for them and their family.
The Need for Multiple Life Insurance Policies
There is a common misconception that you only need/can have one life insurance policy. This is not only incorrect, but it can also lead to planning paralysis as someone frets over which policy type is the one they should choose.
Estate planning often requires a tailored approach, and a single life insurance policy may not be sufficient to address all the financial goals and needs. Here are scenarios where multiple life insurance policies might be necessary:
- Different Coverage Amounts
Different life insurance policies can be purchased to provide varying levels of coverage. For instance, a term life policy might be used to cover immediate financial obligations, while a permanent life policy could provide a more significant, long-term benefit. - Specific Purposes
Separate policies can be dedicated to specific purposes. One policy might be earmarked to pay off a mortgage, another to cover estate taxes, and yet another to fund a trust for a minor child or a special needs dependent. - Diverse Beneficiaries
Multiple policies allow for designating different beneficiaries for each policy, ensuring that each individual or entity receives the intended amount without the need for complex distribution arrangements. - Policy Types
Utilizing different types of life insurance can optimize the benefits. To learn more about different policy types, the benefits they offer, and when you might consider using each, you can see our piece on that here.
Strategies for Effective Use of Life Insurance in Estate Planning
To maximize the benefits of life insurance in estate planning, consider these strategies:
- Regular Review
Periodically review your life insurance policies and estate plan to help ensure they align with your current financial situation and goals. Life changes such as marriage, divorce, the birth of a child, or significant changes in assets should prompt a review. To take a deeper look at policy review, you can read our piece on the subject here. - Work with Professionals
Collaborate with financial advisors, estate planning attorneys, and insurance specialists to create a comprehensive plan. These professionals can provide valuable insights and help address relevant legal and financial considerations. - Plan for Potential Changes
Life insurance policies can offer riders and options that allow for future adjustments. For example, an insurance policy with a conversion option can be converted from term to permanent coverage, ensuring continued protection.
Life Insurance is Made for Estate Planning
Life insurance is like a Swiss army knife for estate planning, offering the necessary liquidity, tax efficiency, and flexibility to meet various financial goals and needs. By understanding the cost implications of obtaining liquidity from life insurance versus other potential sources, you can create a robust and effective estate plan.
Remember, working with experienced professionals, like those at C3 Financial Partners, and regularly reviewing your plan can help ensure that your estate is managed according to your wishes and provides the intended benefits to your heirs. With thoughtful planning and strategic use of life insurance, you can secure your legacy and provide for your loved ones’ future financial well-being.
Securities offered through Valmark Securities, Inc. member FINRA, SIPC. Investment advisory products and services offered through Valmark Advisers, Inc., an SEC Registered Investment Advisor. Representatives may transact business, which includes offering products and services and/or responding to inquiries, only in state(s) in which they are properly registered and/or licensed. C3 Financial Partners is a separate entity from Valmark Securities, Inc. and Valmark Advisers, Inc.
