Close Close

Financial Planning > Trusts and Estates > Estate Planning

Life of the estate planning party

Your article was successfully shared with the contacts you provided.

Advisor Joel Javer, CFP, has a message for people who think their estate planning worries will suddenly evaporate come 2010 when the federal estate tax is scheduled for full repeal: Think again.

Javer, principal at the Sharkey, Howes & Javer advisory firm in Denver says as long as people have assets to transfer at death and a desire to leave a financial or philanthropic legacy, there will be a need for estate planning, regardless of prevailing tax rates and promised tax cuts. And as long as there’s a need for estate planning, there will be demand for life insurance products. “Most people, when they think of estate planning, they think only of estate taxes,” he explains. “But there’s a lot more to estate planning than just [addressing] taxes.”

Not only does life insurance serve a valuable purpose in mitigating an estate’s tax exposure, it’s a versatile tool for minimizing risk and maximizing wealth transfer. Most estate planning maneuvers involving life insurance aim to take advantage of two fundamental features: the ability to transfer a policy’s death benefit tax-free to beneficiaries and to grow cash inside a policy on a tax-deferred basis.

Those features make life insurance a powerful estate planning instrument, says Robert C. Kulle, Jr., a life insurance and wealth transfer planner based in Thousand Oaks, Calif. Investing in life insurance “allows estates to leverage their assets for one to five cents per dollar.”

Many advisors thus turn to life insurance as a cost-effective means of protecting, managing and generating assets. “Risk management is a huge part of any estate plan, and life insurance certainly can help in that regard,” says Rod Hormell, CEPS, CSA, of ESP Estate Planners in Thousand Oaks.

“When you use life insurance in an estate planning context, usually all you’re doing is trying to solve money problems,” adds Ben G. Baldwin, CFP, CLU, ChFC, president of Baldwin Financial Systems in Arlington Heights, Ill.

From the obvious to the more obscure, the simple to the complicated, the applications for life insurance in an estate planning setting are many. Here are some the experts say are worth considering:

  • To cover estate taxes and other obligations an estate might have. People who don’t want to leave estate tax liabilities to heirs often invest in a permanent life insurance policy, the proceeds of which can be used by beneficiaries to cover taxes upon the death of the insured. “It’s covering the expenses that arise when you leave the planet,” explains Hormell, “so it’s really protecting your spouse, your family and your heirs.”

    Often a policy purchased for this reason resides within an irrevocable life insurance trust, notes Javer. If the trust is properly structured for tax-minimization purposes, the policy will reside outside the estate, with the ILIT as its owner and beneficiary. Life insurance policies structured to emphasize death benefit over cash value are best suited for this application, he adds.

  • To gain long term care insurance coverage, such as by exchanging an existing life insurance contract for another one that covers long term care expenses via an accelerated death benefit rider. This maneuver is best suited to clients who want to protect their assets for heirs but don’t want to pay for a stand-alone LTCI policy, says Kulle. “The goal with the exchange is to end up with a new policy that has the same death benefit, the same premium and the same cash value, but with an accelerated benefit rider. It’s a great plank in the estate planning portfolio.”
  • To sell a life insurance policy in the secondary market via the life settlement process in order to generate additional liquidity. Life settlement is not an option to be dismissed out of hand, says Hormell. For people who own a life insurance policy and are facing liquidity issues later in life, selling a policy via life settlement can be a viable alternative to selling other assets that they would rather pass on to heirs. Such a maneuver is especially appealing in cases where collecting on the death benefit and covering estate taxes are not priorities, he says.
  • For estate equalization, a person who owns an asset such as a business that can’t readily or straightforwardly be divided among heirs may look to buy a permanent life insurance policy. Say, for example, a husband and wife with multiple children own a business, and just one of the children is involved in that business. According to Baldwin, they can leave the business to that one child and provide equal value to their other children by making them beneficiaries of a second-to-die life insurance policy.
  • To generate liquidity for such purposes as fulfilling terms of a buy-sell agreement. If one partner in a business dies, and that person is the insured on a life insurance policy that names the surviving partners in the business as beneficiaries, the surviving partners can use the death benefit to purchase the deceases partner’s interest in the business from that person’s estate, Javer explains. Either a term or a permanent policy will work in such a situation, depending on cash-flow circumstances and expectations, he notes.
  • As part of a wealth replacement maneuver. Assets such as low-basis stock or highly appreciated real estate that present heirs with potentially major capital gains tax liabilities can be moved out of the estate, into a charitable trust, to avoid the tax exposure, says Javer. A permanent life insurance policy then can be purchased, with its death benefit replacing the value of the assets that were removed from the estate.
  • To serve as an arbitrage vehicle that offsets the potentially steep tax tab associated with an IRA or pension. A so-called “IRA (or pension) rescue” incorporates life insurance to defray some or all the tax liability associated with qualified retirement assets. According to Kulle, asset-heavy IRAs and pension plans can be “an estate planning nightmare” because they may be subject to both estate and income taxes. In some cases, distributions from an IRA or pension can be used to fund a life insurance policy within an ILIT; ultimately heirs get the policy’s death benefit tax-free instead of an IRA or pension plan that carries huge tax liability.
  • To bolster transferable wealth by purchasing life insurance in tandem with an annuity. When the goal is maximum wealth transfer, it may be worth considering funding the purchase of a permanent life insurance product – usually whole life, universal life or variable universal life – with income created by the acquisition of an annuity contract, usually of the single-premium, immediate variety. One prerequisite to such a maneuver is that the client has adequate cash flow to purchase the annuity. Payments from the SPIA contract afford the client access to a policy with a larger death benefit than they otherwise might be able to afford, with the leveraged dollars of the policy helping to maximize the assets the client can transfer to heirs. It can be set up so that clients don’t have to write regular premium checks to the insurance company, with income from the annuity automatically covering premium payments. Typically the insurance policy is purchased with a no-lapse guarantee to ensure heirs will receive the full death benefit. In many cases the life insurance is purchased by an ILIT so the policy resides outside the estate.

All of the above maneuvers and strategies involving life insurance have proven viable in an estate planning setting, provided they were used in the proper situation and set up in compliance with federal and state laws. Advisors who aren’t well-versed in the intricacies of those seemingly ever-changing laws are wise to consult an estate planning expert. They’re also wise not to use the 2010 federal estate tax repeal as justification for neglecting estate planning altogether.


© 2023 ALM Global, LLC, All Rights Reserved. Request academic re-use from All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.