Life insurance is often associated with providing financial security for loved ones, but it can also be a valuable estate planning tool. Depending on your goals, it may play an important role in your broader estate and wealth transfer strategy.
Like any estate planning strategy, however, the way life insurance is structured and owned can have significant tax and planning implications. Understanding these considerations can help you determine whether life insurance has a role in your estate plan.
Life insurance can help address a variety of planning objectives. It may provide liquidity to pay estate taxes and other expenses, equalize inheritances among family members, preserve family wealth, support charitable goals or facilitate transfers to future generations.
Some individuals name a charitable organization as the beneficiary of a policy as part of their philanthropic plan. Business owners may also use life insurance to fund buy-sell arrangements and stock redemption agreements as part of a broader succession plan. The appropriate strategy depends on your goals, assets and overall estate plan.
Yes. In many cases, ownership can be just as important as the policy itself because it can affect estate, gift and income tax consequences, as well as who controls the policy and receives the proceeds.
If you own a policy on your own life, the death benefit will be included in your taxable estate. As a result, some individuals choose to have a trust, business or another individual own the policy instead. For example, an irrevocable life insurance trust (ILIT) may be used to keep the proceeds outside of the taxable estate, while business-owned life insurance is commonly used to fund buy-sell arrangements or stock redemption agreements.
However, ownership planning extends beyond determining who holds the policy. Questions such as who pays the premiums and whether existing arrangements should be restructured can also have important tax consequences. In some cases, premium payments may be treated as gifts. In other situations, more sophisticated funding arrangements, such as split-dollar life insurance or premium financing, may be used to help fund coverage while managing transfer tax considerations. Before purchasing a policy or transferring an existing one, it is important to understand the implications of the ownership and funding structure.
For a more detailed discussion of trust-owned life insurance, see our article, Estate planning Q&A: Irrevocable Life Insurance Trusts Explained.
Transferring a life insurance policy may seem straightforward, but it can create a variety of tax and reporting considerations. Depending on the circumstances, the transfer may be treated as a gift, requiring the policy to be valued and reported on a gift tax return. Determining that value is not always straightforward and may require information from the insurance carrier and a qualified appraisal. If the trust can benefit grandchildren or more remote descendants, generation-skipping transfer (GST) tax issues may also need to be considered.
In addition, transferring a policy to an ILIT does not always immediately remove the death benefit from your taxable estate. Under the three-year rule, the proceeds may still be included in your estate if you die within three years of the transfer.
Certain transfers can also result in unexpected income tax consequences. For example, the transfer-for-value rules may cause a portion of the death benefit to become taxable if ownership is transferred in exchange for valuable consideration and an exception does not apply.
Because the tax treatment of a transfer depends heavily on the facts and circumstances, it is important to evaluate the transfer before it occurs.
Many life insurance planning issues arise when the policy is viewed in isolation rather than as part of a broader estate plan. A policy may provide the desired death benefit, but ownership, beneficiary designations and funding arrangements can significantly affect the ultimate tax and planning results.
Administrative and reporting requirements can also be overlooked. Gift tax returns may be required when policies are transferred to trusts or premiums are paid on policies owned by others. For trusts that can benefit grandchildren or more remote descendants, generation-skipping tax exemption allocations and elections should be reviewed to ensure they are consistent with the intended planning objectives. Otherwise, trust assets may be inadvertently exposed to generation-skipping transfer tax.
Complex life insurance arrangements may also require ongoing administration and monitoring to ensure they continue to operate as intended and remain aligned with your planning objectives.
Yes. Family circumstances, estate tax laws, business interests and financial goals can all change over time. As a result, a life insurance strategy that made sense years ago may no longer align with your current objectives.
A review can help confirm that policies are performing as expected, existing trusts continue to achieve their intended purpose and funding arrangements remain sustainable. It may also identify opportunities to modify, simplify or unwind an arrangement that no longer meets your needs.
Life insurance can be a flexible planning tool, but the details matter. Ownership, funding arrangements and tax reporting requirements can all affect the ultimate outcome. Periodic reviews can help ensure your life insurance planning remains aligned with your family's goals and avoids unnecessary surprises.
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