Visit Us
1350 Euclid Ave., #280 Cleveland, OH 44115
In this blog post, we discuss the tax benefits of using life insurance as part of your estate planning. Incorporating a life insurance policy into your overall estate planning strategy can allow you to take advantage of potential tax benefits, as well as ensuring that your designated beneficiaries receive a tax-free death benefit from the policy once you pass away. Life insurance estate planning strategies may also help to limit the tax liability of your estate by keeping some assets out of the total amount that will be computed in the gross estate value once you are gone. The tax benefits life insurance estate planning offers can vary widely depending on the type of policy and the amount of cash value involved, so you may wish to consider speaking with an experienced estate planning attorney who can help you evaluate your options.
Life insurance policies are among the most popular estate planning tools. Their primary purpose in most cases is to make sure that the insured person’s loved ones have a relatively quick source of financial relief in the days and weeks immediately following the policy holder’s death. However, there can also be a number of tax implications for the policy holder as well, depending on the type of policy selected and the way the plan is structured.
Particularly for situations in which the policy holder’s closest family members have limited financial resources or there may be an expectation of unusually steep expenses related to the deceased person’s final arrangements, it can be important to ensure that the costs associated with the individual’s funeral do not leave family members struggling to meet their own basic needs while they grieve. For obvious reasons, it is not possible to fully predict when expenses for end-of-life care and final arrangements may represent a special burden, but some common indicators include fixed-income financial circumstances for close family members and the expectation of long-distance, perhaps even international, travel requirements associated with attending the funeral.
Life insurance policies can also be a high priority for individuals of working age who are the primary “breadwinners” for their households, especially if they are paying a mortgage on the family home. People in these circumstances often take out life insurance policies designed either to cover the cost of the mortgage if they die unexpectedly before the debt can be paid off, thereby ensuring that at least the family they leave behind will have the security and peace of mind of knowing they have a place to live, or to make up for the household’s sudden loss of income in the immediate aftermath of an untimely death.
Depending on the type of policy and the terms of the plan, many life insurance policy options can offer a number of tax advantages. Factors to consider in evaluating whether life insurance estate planning for tax benefits makes sense for your situation include the length of time you expect to maintain the policy, the number of beneficiaries you hope to designate, the amount you are prepared to pay in premiums over time, and the degree of flexibility you want to enjoy over the lifetime of the policy. An experienced estate planning attorney from Rhodium Law may be able to help you evaluate the tax benefits life insurance might offer in your situation.
Life insurance can be an effective means of leaving someone a small inheritance that does not have to go through the probate process. Because the Internal Revenue Service (IRS) does not usually consider life insurance payouts to be part of the beneficiary’s taxable income, the person receiving the benefits will not typically have to pay taxes on any payments they receive from a life insurance policy. Additionally, life insurance policies are not considered part of the decedent’s estate, so they will not go through the delay of the probate process and are not subject to federal estate taxes, which may be a concern for individuals whose estates are likely to exceed the federal threshold for estate tax, even though the State of Ohio no longer imposes an estate tax of its own.
This combination of factors means that a life insurance policy can be a good way of ensuring that the designated beneficiary is able to receive a financial inheritance quickly and without penalty. However, given that insurance premiums are generally scaled to the size of eventual payout and that in many cases these premiums must be paid for several years, if not decades, using a life insurance policy on its own can be an expensive means of passing on a substantial inheritance. Individuals who have significant wealth to pass on, but are concerned for their loved ones’ immediate financial needs, may wish to consider using a life insurance policy in combination with other estate planning tools to achieve a cost-effective balance.
Estate planning with life insurance can offer a few tax advantages to policyholders, depending on the cash value of the policy and the way the plan is structured. In most cases individuals wishing to use life insurance to avoid taxes during their own lifetime will need to purchase a type of “permanent,” rather than term, type of policy.
There are two basic categories of life insurance: term and permanent. Most “term life” policies are generally similar in structure and offer similar options for estate planning; “permanent” policies, on the other hand, come in several subcategories and may be structured in a number of different ways.
“Term” life insurance derives its name from the fact that each policy is good for a specific period of time (or “term”). Terms are commonly available in increments of five to 10 years. Many term life plans offer an option to renew the policy once the original term expires, but the renewed policy may be subject to a higher annual premium than the rate established for the original plan.
Term life insurance policy premiums in general tend to be somewhat lower than those associated with the various permanent plans, but term life policies also offer commensurately fewer advantages, especially to their holders (as opposed to designated beneficiaries). Common reasons for taking out a term life policy include making provisions to cover the cost of a mortgage in the event that the homeowner dies unexpectedly before paying off the debt, and ensuring that a surviving spouse and children will have access to a near-future replacement for lost income if the family’s primary earner passes away. As with other forms of life insurance, the benefits from term life policies can generally be paid directly to beneficiaries upon proof of death and the claimant’s identity, so although term life plans offer limited benefits to the individuals who maintain them, they can be an important estate planning tool when making sure that loved ones’ immediate financial needs will be met is a top priority.
Permanent life insurance policies come in several varieties. Whole and universal life insurance policies are among the permanent policy types most widely used by people seeking to manage their tax liability with life insurance estate planning. The major advantage of permanent life insurance policies for estate planning is that these plans typically have a cash value, which may be used in a variety of ways, depending on how the policy is structured.
The tax benefits life insurance estate planning offers for beneficiaries typically apply regardless of the type of policy selected. For the policyholder, on the other hand, there can also be a number of possible tax advantages to estate planning with life insurance, but these will depend on the structure of the policy.
Generally speaking, individuals who wish to use life insurance estate planning to minimize their own tax liability will most likely wish to select a “permanent” type of life insurance, rather than taking out a term life policy. This is because most of the tax benefits life insurance can provide to policyholders are based to some extent on the cash value of the policy. Term life policies do not typically have a cash value, so although their premium costs may be lower than those involved in maintaining a permanent life insurance policy, there are also fewer opportunities for the individuals who hold these policies to use them in managing their personal tax liability during life.
A whole life insurance policy does not expire during the policyholder’s lifetime. This built-in longevity can protect the value of the policy against potential premium increases based on the policyholder’s increasing age and declining health, making this type of policy potentially attractive for individuals who want to lock in a fixed premium. Whole life policies also typically offer a “cash value” that earns interest over time. This interest is tax-deferred while it is accruing, and only taxed as it is withdrawn. The combination of this tax-deferred with the fact that many people move down to a lower tax bracket as they enter retirement means that some holders of whole life insurance policies choose to withdraw portions of the interest accumulated on the cash values of their policies during retirement, as a supplement to whatever pensions they have already in place, at a point when their income from the interest will be taxed at a lower rate than it might have been only a few years previously.
Like “whole life” policies, universal life insurance lasts throughout the insured person’s lifetime. These policies also typically offer a cash value – but unlike whole life insurance, both the premiums and the death benefits available to the beneficiaries designated in the policy documents may be subject to adjustments over time.
Universal life insurance policies come in two main subcategories:
A variable universal life insurance policy will be tied to investment options that are organized into “sub-accounts”; the fate of those investments helps to determine both premium and benefits. An indexed universal life insurance policy is instead tied to an external measure (such as a stock market index). Both variable and indexed universal life insurance policies offer policyholders options for managing their tax liability by making strategic withdrawals, but “universal life” plans tend to offer somewhat greater flexibility than whole life insurance policies. They can also be more complicated as a result, so consider speaking with an experienced accountant or tax attorney to review the potential advantages and implications for your particular situation.
Estate planning with life insurance can have a number of benefits, but these can vary widely depending on the terms of the policy chosen as well as the amount paid in over time. Discussing your life insurance estate planning options with an experienced estate attorney may help you to determine which options offer the most appropriate fit for your situation and priorities.
To discuss the tax benefits life insurance estate planning may offer to your and your beneficiaries with a member of the dedicated and knowledgeable team at Rhodium Law, call (216) 699-8145 today and request your free initial consultation.
