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Life Insurance Strategies for Estate Planning

Jan 04, 2022 4 min read Riley Adams, CPA

Key takeaways

  • Life insurance provides money to the people who depend on you when you pass away, even if you have a large estate.
  • Large estates can face a tax bill but have insufficient liquid assets to cover the expense.
  • Avoid this cash crunch by considering life insurance strategies for estate planning needs.


It’s important to have the right strategy in place to protect your loved ones in the event of your death. Proper estate planning allows you to manage your assets while you're alive and lay out exactly how you'd like them distributed when you die.

If you feel your heirs will not be supported after you die or that they might have to sell parts of your estate to pay estate taxes, you might consider purchasing life insurance. This article will walk through life insurance strategies for estate planning, as well as how life insurance can help.



Life insurance strategies for estate planning and why they matter

Estate planning needs differ for everyone depending on your estate, age, wealth, health, lifestyle and more. Regardless of your situation, life insurance estate planning strategies are a must, especially in the midst of the ongoing health pandemic.

When you start planning your estate, you might discover yours just requires a simple will to decide how assets will go to heirs. Complex financial situations call for more specific instructions. Either way, having a plan and making your wishes known is important.

Along with having a will, you should consider buying life insurance as a key part of your estate planning strategy. Doing so will help your beneficiaries maintain a good standard of living without you. It will also lessen the burden on your loved ones during an already sad and stressful time.

Upon your death, you can use the life insurance proceeds to pay for estate taxes as well as provide financial resources to your heirs. When used in conjunction with a will or living trust, insurance payouts will give your beneficiaries greater financial certainty and ease their legal burdens after you're gone.


Using life insurance benefits in estate planning

If you have a large amount of assets when you die, your beneficiaries may owe estate taxes when settling your estate. If this is the case, and your estate includes assets like a house, vacation property, jewelry, or other sentimental items, you surely don't want your heirs to be forced to sell these things just to pay the tax bill.

Instead, you can purchase life insurance to provide immediate cash. Your beneficiaries can use your life insurance payout, a lump sum of cash which will generally be tax-free, to cover these estate taxes—or any expenses they might have—without liquidating your estate.


Irrevocable life insurance trusts

In addition to using life insurance, you can also explore an irrevocable life insurance trust (ILIT) to transfer your wealth in a tax-smart way. With this strategy, you'll buy a life insurance policy for yourself and transfer it to the ILIT. Your heirs are made beneficiaries of the trust and the proceeds of the insurance policy are distributed to them after your death.

The policy's death benefit usually passes to the ILIT's beneficiaries tax-free. It is not included as part of your estate and not subject to federal estate taxes. Without an ILIT in place, the death benefit from your policy will be included in your gross estate. This amount could be subject to estate taxes.

ILITs must have a grantor, trustee(s), and beneficiary(ies). The grantor purchases the policy to fund the ILIT and gifts this policy to the ILIT permanently (hence, the name "irrevocable"). The grantor appoints a trustee to manage and distribute the funds to the ILIT's beneficiaries.

If you transfer an existing life insurance policy into the trust, you will encounter a three-year lookback period    PDF opens in new window. This means that any payout issued within three years of transferring the policy into the trust will be counted in your estate.

You should consider whether the size of your estate will be big enough to incur federal estate taxes ($12.06 million in 2022 Opens in new window). If so, it's wise to organize this strategy with an estate planning professional sooner rather than later.



What you can do next

No matter how big or complex your estate is, think about where you want your assets to go when you die. Make an appointment to speak with a certified professional who can help you build an estate planning strategy best aligned with those wishes.


Please consult your tax and legal advisors regarding your particular circumstances.

Author detail

Riley Adams, CPA is a senior financial analyst at Google with over a decade of professional experience. He has written for MarketWatch, Kiplinger, MSN, Yahoo Finance, Morningstar and TDAmeritrade, as well as his own personal finance website.


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