When they hear the term “life insurance,” people usually think of an insurance policy that will provide financial protection for their family when they die. But life insurance can also be used in creative ways to accomplish other financial goals beyond just providing your loved ones with a death benefit.
When used strategically, life insurance can be a valuable estate planning, business succession and charitable giving tool for affluent and high-net-worth individuals. Following is an explanation of the role life insurance can play in each of these areas.
Liquidity for Estate Planning
When used as a component of your estate plan, life insurance can help you leverage liquidity in order to prepay estate taxes. A life insurance policy can be the vehicle used to gift assets to your heirs so they are removed from your taxable estate.
In 2016, the top estate tax rate is 40 percent, which is applied to estates worth more than $5.43 million (or to the estates of married couples that are worth more than $10.86 million). Individuals and couples with estates that are larger than this can use life insurance to transfer up $14,000 per year (or $28,000 for married couples) to their heirs, which may reduce the amount of estate taxes heirs have to pay.
Another strategy is to establish an Irrevocable Life Insurance Trust (ILIT) outside of your estate and make annual gifts to the trust. This cash would be used to buy a life insurance policy with your heirs listed as the beneficiary. The proceeds of the policy could then be used by your heirs to pay estate taxes and settle any other estate expenses smoothly and efficiently.
Ensuring Business Continuity
One of the biggest succession challenges many business owners face is ensuring that their business will continue if they unexpectedly die or become disabled. If this isn’t planned for in advance, there’s a good chance the business will not survive the turbulent transition period.
The best way to plan for a smooth business transfer in this situation is to create a buy-sell agreement funded by life insurance. Here’s how it works: After choosing a successor — such as a key employee or outside stakeholder — you will draft an agreement that establishes the business’ value. Or the agreement may create a formula for establishing the business’ value upon your death or disability.
The appointed successor will purchase a cash-value life insurance policy on you that will pay out upon your death or permanent disability. He or she will then use these proceeds to buy the business at its established value. Your family, meanwhile, will receive cash from the sale to meet their ongoing living expenses.
More Tax-Efficient Charitable Giving
You probably give money to charities and causes you’re passionate about. However, life insurance may enable you to reap tax and estate planning benefits from charitable giving. This can be accomplished by distributing your gifts to a Charitable Remainder Trust (CRT) instead of giving them directly to a charitable organization.
With this strategy, you will receive income generated by the CRT’s assets as well as a current income tax deduction for your charitable contributions. When you die, the assets remaining in the trust will go to your designated charity. Meanwhile, you will use the income you receive from the trust assets to purchase a life insurance policy listing your family as the beneficiary.
If you have more questions about how to use life insurance creatively, please give us a call. We can help you utilize life insurance as part of your overall estate planning, business planning and charitable giving strategies.