Life insurance is an important tool that can be used to protect your legacy and family in the event of your death. It can provide liquidity to pay for estate taxes, funeral expenses, and other debts, and it can also be used to leave a financial legacy to your loved ones. Business owners often use life insurance to fund buy-out agreements with their co-owners or to insure against the untimely death of a key employee.
There are two basic types of life insurance: term life and permanent life. Term life insurance provides coverage for a specific period, typically 10, 20, or 30 years. If you die during the term of the policy, your beneficiaries will receive a death benefit. However, if you outlive the term of the policy, you will no longer have coverage. Permanent life insurance provides coverage for your entire life, so long as you pay the premiums. Permanent life insurance policies also have a cash value component, which grows income tax-free inside the policy while the policy is in force. You can borrow against the cash value or withdraw it tax-free, generally up to the amount of the premiums you have paid.
How Life Insurance Can Be Used in Estate Planning
Life insurance can be used in estate planning in many ways. Here are a few examples:
- To pay estate taxes: Estate taxes are a federal tax that is imposed on the transfer of assets from a deceased person to their beneficiaries. If your estate is valued above the then “applicable exclusion amount” (currently $13.61 million, but reducing by 50% in 2026), your beneficiaries may have to pay estate taxes. Note that Massachusetts has a separate estate tax with only a $2.0 million exemption so many clients may have a significant estate tax to pay to the Commonwealth at rates from 5-16%, Life insurance can be used to provide liquidity to pay such estate taxes, so that your beneficiaries do not have to sell assets to cover the tax bill.
- To replace lost income: If you are the primary earner in your family, your death could have a significant financial impact on your loved ones if you die before accumulating enough wealth for their support. Life insurance can be used to replace your lost income, so that your family can maintain their standard of living after your death.
- To pay for funeral expenses and other debts: Funeral expenses and other debts can add up quickly. Life insurance can be used to pay for these expenses, so that your loved ones are not burdened with financial hardship after your death or forced to sell possibly illiquid assets or at an unfavorable time in the marketplace.
- To provide liquidity for business owners: Buy-sell agreements among co-owners often are funded with life insurance to avoid having a deceased owner’s estate as a successor owner in the business. Liquidity may also be needed to pay-off a business debt or bank line of credit if an owner dies.
- To leave a financial legacy to your loved ones: Life insurance can be used to leave a financial legacy to your children, grandchildren, or other beneficiaries such as your favorite charity. You can use life insurance to pay for their education, start a business for them, or simply provide them with a financial cushion.
When choosing a life insurance policy, there are several factors to consider, such as:
- The type of coverage you need: Do you need term life insurance or permanent life insurance? If you need term life insurance, how long of a term do you need? If you need permanent life insurance, what type of policy do you need and is best suited to accomplish your objectives
- The amount of coverage you need: How much life insurance coverage do you need to meet your estate planning goals?
- Your budget: How much can you afford to spend on life insurance premiums?
- Use a qualified insurance advisor: You should consult with a licensed and experienced insurance agent who has the Chartered Life Underwriter (CLU) designation to help with an analysis of the proper policy for your needs.
Once you have established the right insurance policies to support the goals of your estate plan, be sure to maintain and review them as you age and as your objectives change. Here are three key steps to a proper monitoring of the insurance policies in your estate plan:
- Name a beneficiary and review periodically: When you purchase a life insurance policy, you will need to name a primary beneficiary. The beneficiary is the person who will receive the death benefit when you die. Note that the death benefit is generally received income tax-free by the beneficiary. You can name multiple beneficiaries. You should also name a contingent or secondary beneficiary, who will receive the death benefit if your primary beneficiary dies before you.
- Consider a transfer ownership of the policy to an irrevocable trust: If you own a life insurance policy, the death benefit will be included in your taxable estate. However, you can avoid this by transferring ownership of the policy to an irrevocable trust. Properly structured, the death benefit will be removed from your taxable estate and will pass to your beneficiaries estate tax-free.
- Keep your policy current: Make sure to review your life insurance policy regularly to ensure that it still meets your needs. As your situation changes, you may need to adjust your coverage or purchase additional policies. Reviewing the policy performance annually with your life insurance advisor should be part of your overall financial planning agenda.
