Life insurance can be an integral part of an estate plan. Policies can be set up to be paid directly to the beneficiary without the need to pass through the probate estate, and may be put in place as part of an overall strategy to pass wealth on to family. Life insurance proceeds transfer to the beneficiary without having to pay income tax and with proper planning, may also avoid the estate tax. Having life insurance ensures that some assets will be liquid, so that non-liquid assets, such as real property, will not have to be sold to pay estate debts, expenses or the estate tax.
An attorney can set up a life insurance trust to avoid estate taxes on the proceeds. A life insurance trust must be irrevocable, cannot be managed by the policyholder, and must be in place at least three years before the death of the policyholder unless the trust purchases the policy. Then, all policy proceeds paid on death from life insurance owned by the trust is not considered by the IRS as part of your taxable estate. The need for this trust is not as common today since the exemption for estate taxes is currently almost five and a half million dollars, but it is a useful tool for those whose estates may be subject to estate taxes.
There is a limit to how much life insurance an individual is permitted to purchase, depending on age and income. And life insurance may not be an option for some people who are now uninsurable.
Life insurance as a part of estate planning is a complicated issue. It makes sense to consult with an estate attorney and a tax professional before meeting with an insurance broker. Both can help you understand the benefits of insurance and whether it is a good part of your estate planning strategy.