topic | life planning - legacy

Step 4: life insurance

Life insurance is part of many estate plans. It can provide income replacement, help wealth accumulation, cover educational expenses, and provide liquidity to pay estate taxes, death taxes, and funeral expenses. Type of insurance needed and associated coverage can vary.

Activity 1
Understand life insurance types

There are four main life insurance types.

Term Life insurance pays a predetermined sum if the insured dies during the life of the policy (typically 5, 10 or 20 years). Upon the death of the insured, the insurer pays the face value of the policy to the named beneficiary. Features:

  • Insurance protection for a fixed time period
  • Low cost
  • No cash value
  • Usually renewable
  • Sometimes convertible to whole life insurance

Whole Life provides lifetime coverage. It is typically comprised of two parts: a saving or investment portion and an insurance portion. Whole Life uses consistent premiums and a guaranteed cash value to match the long-term goals of the insured. There is an insurance component that pays the contracted amount upon death of the insured. A second component to the policy accumulates a cash value over time that can be withdrawn or borrowed against. Features:

  • Coverage guaranteed for the insured's "whole life"
  • High cost
  • Cash value accumulates over time on a tax-deferred basis
  • Insurerdetermines the fixed rate of return over the life of the policy.
  • Long term estate planning tool

Universal Life(UL)/Universal Variable Life(UVL): These two insurance policies are variations of Whole Life insurance. They provide flexibility in premium payments, death benefits, and savings element of the policy. Features:

  • UL - Savings component interest rates are set by the insurer
  • UVL - Flexibility in investments, the insured takes the risk on investment direction
  • Both - Variabliity in death benefit payouts as determined by the insured
  • Both - Cash value accumulates over time on a tax deferred basis
  • Both - Long term estate planning tool

Group Life Insurance: This is life insurance available through some employers as part of the overall benefit package, or to members of large associations and trade groups (e.g. credit unions, labor organizations). The type of insurance and death benefits available varies by organization. Features:

  • Lower cost than individual plans for same coverage
  • Employer sometimes offers with no out-of-pocket premium charges
  • Could include AD&D (accidental death and/or dismemberment) coverage
  • Might include supplemental insurance for an additional fee
  • Could be transferable to another employer

Activity 2
Selecting an insurance company

The financial strength of the insurance company is paramount. To evaluate, utilize the services of a large rating agency such as A.M. Best, Moody's Investment Services, or Standard & Poor's. Consumer Reports is another source for ratings, articles, and information about the life insurance industry. Ratings are available on-line, in libraries, or from insurance agents/brokers. Ratings do not guarantee safety, but they do help assess a company's financial health.

Activity 3
Life Insurance Trusts in an estate plan

Life insurance is often put into a trust as a component of an estate plan for financial, tax, and legal reasons. This structure is called a Life Insurance Trust. Because of the complexity involved, it is important that a financial advisor orestate attorney be consulted. Features:

  • Allows the Grantorto determine distribution of benefits to beneficiaries
  • Can specify funds to be held liquid (available cash) to pay taxes and debts.
  • If minors are involved, the trust can control how and when funds are distributed to the minors.
  • Minimizes federal estate taxes.
  • Most are irrevocable (i.e. Irrevocable Life Insurance Trust or ILIT), which means once set up, no changes can be made to beneficiaries.

Activity 4
Life Insurance Beneficiary considerations

Individuals, charities and other organizations, trusts, or estates can be assigned as benficiaries of life insurance policies. If no beneficiary is designated, the proceeds typically flow to the estate to be distributed according to the Will.

  • Avoid designating as a beneficiary someone who has been determined to be "incapacited" or "mentally incompetent" (i.e. unable to make a decision) as court involvement may be required prior to distribution of funds. The same issue may apply to minors.
  • A beneficiary who is also currently receiving government assistance could lose that benefit or have it significantly reduced.
  • Distribution of funds to beneficiaries can have tax consequences for the estate. Careful planning should be made to avoid excessive taxation.
  • The beneficiary owns the death benefit and is under no obligation to pay estate debts, or share proceeds.
  • Consider contingent, or secondary beneficiaries, in case the primary beneficiary pre-deceases.
  • Consider an ILITto control how the proceeds are distributed and the timing of distributions.  This might be a good option for minors or a disabled child.

It is very likely that the designated beneficiaries may change throughout the life insurance coverage period. It is recommended to record the beneficiaries and review the documents periodically. Forms Insurance Policies and Life Insurance provide a quick resource for recording and updating life insurance information.

Best Practices

Always inform beneficiaries of the life insurance policy, where the policy is stored, and provide a copy. Many policies go unclaimed because the beneficiary was unaware of its existence.

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