Proceeds from life insurance can be used to cover taxes and funeral expenses while protecting other assets so they don’t have to be sold to cover costs.
Life insurance is a very useful and often overlooked planning tool that has many different applications. One key function: providing liquidity for estate plans, as reported in FEDweek’s article, “Proper Use of Insurance in Estate Planning.”
For example, if Dad passes away and leaves a sizeable estate to his daughter Bev, there could be a big estate tax due. But if most of Dad’s assets are tied up in real estate and an IRA, Bev might not want to be in a hurry to sell the real estate. She might think about withdrawing some of the inherited IRA to raise cash, but she’ll have to pay income tax on the withdrawal and lose a valuable chance for extended tax deferral.
A better strategy would be for Dad to buy insurance on his own life, and use those proceeds to pay the estate taxes. Then Bev can keep the real estate while taking only minimum required distributions (RMDs) from the inherited IRA. If the insurance policy is owned by Bev or by a trust, the proceeds probably won’t be in Dad’s estate and won’t raise the estate taxes.
Here are a few common life insurance errors that can wreak havoc with an estate plan:
- Naming your estate as beneficiary. This puts the policy proceeds in your estate, exposing the money to estate tax and creditors. It also gives your executor more paperwork if your estate’s the beneficiary. Instead, be certain to name the appropriate people or charities.
- Naming just one beneficiary. Designate at least two backup beneficiaries to eliminate confusion if the primary beneficiary dies before you.
- Filing your life insurance and forgetting about it. Review your policies at least once every three years for changes in life circumstances.
- Having too little insurance. With a young child, it’ll take hundreds of thousands of dollars to pay all his or her expenses, like college bills, in the event of an untimely death.
Term insurance is a very inexpensive way to provide your heirs with a healthy cushion against anticipated and unanticipated expenses. When whole life insurance policies are not feasible, term life is an affordable alternative.
Reference: FEDweek (November 3, 2016) “Proper Use of Insurance in Estate Planning”