When many people think of estate planning, they picture wealthy individuals huddled around a conference table with their CPAs and tax attorneys, strategizing how to pass all of their vast personal and business holdings to their heirs. And there is a measure of truth to that.
But estate planning isn’t just for the rich. Do you have assets that you want to pass to your loved ones when you die? Do you want to do it in the most expedient and tax-efficient manner possible? If so, you need to do your estate planning.
A life insurance policy can play a vital role in ensuring your beneficiaries receive all that you want them to, with as few complications as possible.
In this article, we’ll delve into a few estate planning basics before introducing how life insurance can be a critical element of an effective estate plan. We’ll also tell you how to determine how much life insurance you need and what type to get.
What is estate planning?
Estate planning isn’t complicated – it’s simply financial planning for how you want to divide your property and assets when you die. No matter how many zeroes you have in your bank account, estate planning is essential. If you have people you care about and want the best for after you pass, you need to spend some time planning your estate.
There are two primary considerations when it comes to estate planning: property and people (“the 2 P’s”). Let’s look briefly at both.
How does life insurance enter into the estate planning picture?
Once you’ve considered the two “P’s,” property and people, a third “P” must be considered: protection. Your property and the important people in your life need to be protected against a couple of nemeses, namely taxes (income tax, federal estate tax, etc.) and lifestyle damage. Let’s look at each and how life insurance prevents these enemies from gaining a foothold.
Taxes
After you’ve completed your estate planning and directed how you want your property and other assets to be distributed, there is one other entity that must be considered: the tax liability.
If your taxable estate exceeds a certain value, your heirs may need to pay federal estate tax or inheritance taxes at the federal and/or state level. There are three ways for them to pay estate taxes:
- Pay cash: This is not possible for many families
- Sell assets: Your home or some of your other assets may need to be sold to gain liquidity for tax purposes
- Use life insurance: It can be used to pay any taxes due
In most cases, the least expensive of these three options is to use life insurance proceeds. And, if your estate is planned properly, your beneficiaries will receive the policy’s death benefit tax-free.
In some cases, depending on the value of your estate, it might make sense to create an irrevocable life insurance trust (ILIT). This creates an exemption that removes the insurance policy from being counted as an estate asset.
You will likely need to consult an expert on tax law for legal advice.
Lifestyle damage
This is the adversary that concerns most people doing estate planning. In some cases, when you add up the assets, you’ll see that the value of those assets won’t sustain the lifestyle of your survivors in the manner they’re used to. And, of course, you also need to consider final expenses like end-of-life health care and funeral costs.
If you’re still working when you do your estate planning, you’ll see that your biggest asset is your future earnings. For example, if you earn $100,000 per year and have 25 years left before you retire, those future earnings are worth $2.5 million, not taking into consideration any future increases in your income.
Having enough life insurance in place for the payout to replace that income will safeguard your family’s lifestyle. They will be able to continue to stay in the same home if they wish, pay for the children’s education, pay their medical expenses and enjoy life without financial stress. Once you’ve accomplished this, your estate planning will have been a success.
Deciding which type of insurance you need
Deciding how much life insurance you need and what type you should buy are the two biggest hurdles for people buying life insurance. There are two ways to figure out these issues: speak with a life insurance agent or get quotes and buy your life insurance online.
Here are the main types of life insurance:
Term vs. whole life insurance: what's the difference?
The key differences between term and whole life policies are the length of coverage (temporary versus permanent) and whether or not cash value accrual will complement a death benefit.
Term policies are cheaper because they do not build cash value and are shorter-term. However, while rates are fixed in the duration of the policy, once it expires and you’re up for renewal, it gets more expensive over time. Whole life policies are more expensive as cash value gives the policyholder some additional financial leeway. Plus, the length of the policy lasts for as long as they are alive. Premiums remain level from the original effective date of the policy and won’t increase over time.
Some people enjoy getting help from an insurance agent, and some prefer buying their life insurance online. Either way is satisfactory as long as you take care of getting it done. Procrastination will kill an estate plan and put your beneficiaries in harm’s way financially.
Many life insurance websites have “life insurance calculators” that will help you determine how much life insurance you need. There are also sites that will give you quotes on different types of life insurance so you can do some comparison shopping and find the best coverage that fits your budget.
Wrapping up
Estate planning doesn’t need to be complicated. Having an attorney draft the basic documents you need and using life insurance for paying estate taxes and maintaining your family’s lifestyle are things that everyone should do, not just those considered “wealthy.” Not planning your estate or not having enough life insurance in place won’t help you leave the legacy you want and deserve.