Four Important Reasons to Buy Life Insurance
22 July 2014
Life insurance has come a long way since the days when it was called “burial insurance.” Today, a life insurance policy is a crucial part of many financial and estate plans. By carefully setting up your life insurance policy with the help of a financial and/or estate planning professional, you can maximize the value of that policy and potentially reduce your tax liability. But if you don’t set up the policy correctly, you may inadvertently increase the size of your estate and subject it to estate taxes.
How does life insurance fit into a good financial or estate plan? Here are four popular reasons for investing in a life insurance policy.
1. Income Replacement
Life insurance isn’t just about the money: It gives you peace of mind that your family and loved ones will have the resources to maintain the lifestyle you want for them. Take the example of a 40-year-old engineer who makes $150,000 a year and has a wife and three children. For a relatively small amount, he can purchase life insurance sufficient to ensure that his family will be able to replace his income.
2. Retirement Account Protection
A well-structured life insurance plan may also protect your beneficiaries from having to withdraw money from your qualified retirement accounts and pay tax on the withdrawals—which could be as much as 40–50%! One strategy to protect these assets is to create an irrevocable life insurance trust (ILIT). If properly structured, this type of trust can be used to keep the proceeds of the life insurance policy out of the insured’s taxable estate. The trust itself is the owner of the policy and the beneficiary of the proceeds, which then can be distributed to the beneficiaries of the trust, protecting them from the need to withdraw funds from the retirement assets—and from incurring any tax liabilities on those withdrawals.
For example say you have a 65-year-old man with $5 million in a qualified retirement account. If he creates a properly structured ILIT, his widow could receive the proceeds of the life insurance policy, distributed from the ILIT, free of estate and income taxes. Meanwhile, their children can be made the beneficiaries of the qualified retirement account, which, if they invest wisely, could grow significantly by the time they reach retirement age.
3. Protection Against Estate Taxes
Another use for life insurance is to provide liquidity to offset potential estate tax liabilities. If you have a very large estate, you may use required minimum distributions (RMDs) from your qualified retirement accounts to buy life insurance that your heirs can then use to pay any estate tax liability. This eliminates the need to liquidate property or other investments, potentially at a less than optimal value.
4. Buy-Sell Agreements in Closely Held Businesses
A buy-sell agreement among the owners of a closely held business can spell out what happens if one of the owners dies or leaves the business unexpectedly. Such an agreement can describe a plan to maintain business continuity and operations when unforeseen events occur.
Life insurance policies are often used to fund the purchase of the deceased owner’s interest. The business can buy life insurance policies for each owner and name itself as the beneficiary (this is called an entity redemption arrangement), or each owner can own an insurance policy on the other owners, and use the proceeds to buy the deceased owner’s interest (this is known as a cross-purchase arrangement).1
Finally, Be Sure to Designate the Proper Beneficiary!
However you decide to use your life insurance policy, be sure that you designate a primary beneficiary (or beneficiaries) as well as a contingent beneficiary (or beneficiaries). This is critical. The proceeds of your life insurance policy are not determined by your will: they are determined by your beneficiary designations. Just as importantly, review your beneficiary designations with your financial and/or estate planning professional at least annually. Life circumstances tend to change, and you may not want to accidentally leave your carefully arranged life insurance proceeds to an unintended recipient, such as an ex-spouse.
Rigby Financial Group offers comprehensive financial and estate planning services. Please contact us at 504-586-3051 or email Eric Rigby for assistance in creating an individualized financial and/or estate plan tailored to your specific situation and your unique goals.
The information presented here is not specific to any individual’s personal circumstances.
These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.