Traditionally, the purpose of life insurance is to replace a person’s income for their family in the event they die before they stop working. For this reason, many people buy “term” insurance that ends when they reach retirement age.
However, there are also some very good uses for life insurance as part of an estate plan. For example:
- You might want to make sure that your heirs won’t have to sell important assets (a business, real estate, etc.) after you die in order to pay estate taxes or because of a lack of liquidity in the period after your death. Life insurance can provide your heirs with ready cash to cover taxes and other expenses.
- Suppose you have several children and you want to leave them equal inheritances, but your estate consists largely of assets that are hard to divide – such as a business, real estate, or an art collection. You could leave the assets to the children most likely to appreciate them, and use insurance to equalize inheritances for the other children.
- If you leave behind a vacation home for use by multiple family members, they could end up squabbling over who has to pay for upkeep, repairs, and so on. Life insurance could be used to find a trust that pays these expenses.
- Life insurance can also fund a trust to be used for college education or for children with special needs.
You should know that while the beneficiary of a life insurance policy generally doesn’t have to pay income tax on the proceeds, the amount of the proceeds is typically included in your taxable estate. This can be a problem if the value of the proceeds plusyour other assets pushes you into the estate tax bracket.
There are ways to avoid this problem, such as by creating a trust to own the life insurance policy. However, these trusts can have some drawbacks and some very technical requirements, so you’ll want to talk to an attorney to make sure the idea is right for your situation.