Life Insurance As Part of Your Financial Plan

September has been declared "National Life Insurance Awareness Month." This is a great time to assess ones needs, educate oneself on the topic, and develop a financial plan that incorporates adequate coverage for all areas of risk management, including life insurance.

In years past, life insurance was sold and thought of as burial insurance. Many individuals today still use it primarily to pay for burial or final expenses as these costs can be a financial burden on families. There are several other good reasons to purchase life insurance, including replacing lost income, paying outstanding debt, and planning for children's education.

One of the most important roles of life insurance, especially in small business and farm and ranch operations is as an estate and business succession planning tool. To best utilize this tool, one must understand key concepts such as ownership and beneficiary designations, as well as available insurance options.

Three major components of an insurance policy are the insured, the beneficiary, and the policy owner. The insured is the individual or individuals covered by the insurance policy. The beneficiary is the individual (or trust or estate) to whom the death benefits of the insurance policy are payable when the insured dies. Beneficiaries are designated in the policy, and may be changed by the owner at any time through the insurance company when needed.

The owner, as defined by the IRS, has "incidents of ownership" which include the power to obtain a loan against the surrender value of the policy, the power to surrender or cancel the policy, and the power to change the beneficiary. This issue of ownership is critical in cases where the total estate, including life insurance benefits, reaches values subject to estate taxes.

While life insurance proceeds are generally received income tax free by the beneficiary, those proceeds may be subject to estate taxes. The amount of death benefit that would pass income tax free to the named beneficiaries will be included in the gross estate of the owner, subject to estate taxes.

Ownership of a policy is established at the time of purchase of a policy, or can be transferred at a later time; consultation with a tax or financial planning professional is recommended, as ownership issues may have tax implications for the owner even prior to death of the insured party. Understanding and correctly implementing these concepts allows life insurance to be used optimally in estate and business succession planning.

Life insurance can be used for many functions in estate planning. As mentioned above, life insurance can provide a source of money for surviving spouses and children. Life insurance provides a large amount of cash at a relatively low cost. This also provides liquidity when it is needed most, in particular with farm and ranch operations where a majority of the assets are tied up in illiquid assets.

In farm and ranch estates large enough to be subject to estate taxes, families may use life insurance to help pay the estate taxes. Proper planning can also use life insurance to provide an inheritance to adult children not working the farm, while allowing the child working the farm to continue, and keep the farm intact.

These arrangements may be accomplished with the use of an irrevocable life insurance trust (ILIT). An ILIT is an effective estate planning tool, but must be implemented properly, so consultation with an attorney and financial planning professional is important.

While several types of life insurance policies exist, the most common type used in estate planning for larger estates is the "second to die" policy or "survivorship life insurance," as it is sometimes called. This type of policy insures both spouses, and the death benefit is paid only upon the death of the second spouse as this is the time funds are needed to settle estate issues.

Another important area of planning for farms and ranches and other small businesses in which life insurance can be used is in business succession planning. If the business operations is owned and run as a partnership, the premature death of one partner could mean the end of the operation, unless the surviving partner has the assets to buy the remaining interest of the business from the estate of the deceased partner.

Life insurance can fund those buy-sell agreements, providing the assets to allow the surviving partner to buy out the deceased partner's assets, and enabling the business to continue.

In addition, because life insurance proceeds are paid directly to the beneficiary, as long as the estate is not named as the beneficiary, the life insurance proceeds can pass the probate process, saving both expense and delay.

Life insurance can play an important part of an overall estate plan. As family and business situations change, a review of life insurance coverage, including issues of beneficiaries and ownership, is vital. Consultation with professionals in the field is important for full understanding of available options and important tax implications.

September 05, 2013 3:47 pm  •