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Planning With Insurance

Life insurance takes on an increasingly important role in financial planning as people age and accumulate assets. For a working parent in their 30s with two kids, life insurance can help provide income protection should unexpected tragedy such as death occur.

For example, lost income can be replaced if you purchase enough insurance to enable a surviving spouse to invest the proceeds and, in theory, produce an income stream equivalent to the deceased’s lost wages. Temporary (or term) insurance is the usual choice in this scenario and is good for a defined period of time.

But what about life insurance for estate planning? Insurance can be a crucial estate-planning tool, but it’s important to be mindful of the potential to trigger estate taxes

Income and Asset Protection

When using life insurance in your estate planning, income protection is no longer the main goal, but rather, asset protection is. Permanent insurance—whether it is whole, variable or universal life—is usually the recommended solution for an estate-tax or asset-protection issue.

People typically purchase life insurance for estate-planning purposes as a means to fund any estate-tax liability they may have upon their death. Insurance proceeds can help solve liquidity needs as the value of an estate sometimes is comprised largely of non-liquid assets like real estate or collectibles.

But buying insurance shouldn’t be your first estate-planning strategy. Instead, use the following guidelines when doing your estate planning:

  • Review your legal documents (e.g., wills and trusts) and make sure they reflect your goals and intentions.
  • Consider gifting your assets over time in order to reduce your estate-tax liability.
  • Consider purchasing life insurance to provide a financial cushion in the event of a spouse’s death and also help finance estate tax payments.

Tax-Smart Planning

The estate tax exemption in 2016 is $5.45 million for an individual and $10.9 million for a married couple.  These values are indexed for inflation.  However, a new President and Congress can change exemptions so reviewing your plan is critical.

If an estate tax is owed, life insurance provides liquidity if you plan properly. Life insurance proceeds can help fund estate taxes and prevent a fire sale of assets, be it real estate, stock investments or a family business and borrowing to pay taxes is often an expensive option.

Using life insurance to cover your tax bill is one of the primary ways that businesses get transferred from generation to generation. Insurance proceeds can also be a means to distribute an estate more equitably. One heir might receive sole ownership of a business, while another is named the beneficiary of a life insurance policy of comparable value.

Preserving Your Wealth

It is important to avoid incidents of ownership over the life insurance policy. These include: having access to cash values of a policy, being a beneficiary, or paying for the policy directly. If you do, the proceeds may be included in your taxable estate upon your death.

In addition, couples typically should not own insurance on themselves because the insurance may be included in their taxable estate, compounding the estate-tax problem.

A popular technique for avoiding incidents of ownership includes using the annual gift exclusion (currently set at $14,000 in 2016) to gift cash to a trust in their children’s names. Here, the trust purchases the policy and is the life insurance beneficiary. However, the trust is irrevocable, so it’s advisable to set aside enough assets for you to live on for the next 20 or 30 years, after taking the gifting schedule into account.

The key to determining how much life insurance you may need is to have a financial advisor do financial modeling to assess what your cash flows will look like 20 or 30 years from now.

Your advisor can help estimate a projected net worth by reviewing annual expenses, gifting programs and investment returns.

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Planning Solutions Group, LLC