How Life Insurance Fits Into One’s Estate Plan


There are many reasons why one might obtain life insurance and the purchase of such insurance should seriously be considered when doing estate planning. The most common situation where life insurance is necessary is in the case of a couple who has young children.  In that situation, it is common for one or both spouses to obtain term insurance, which is generally not terribly expensive but lasts only for a term of years, to provide the funds necessary to raise the children if something were to happen to one or both parents. While there is no cash value to such policies, the cost is considerably less than whole life  and variable insurance and it covers a temporary need.

Life insurance is also an important component of the estate plan of someone who may have substantial assets but whose assets are not liquid.  So, for example, if one has the bulk of their assets tied up in real estate, a business, retirement assets, or any combination thereof, it is important to have life insurance that will provide monies to one’s estate so that expenses and taxes can be paid without the need to quickly sell or liquidate assets.  In this situation, permanent insurance, as opposed to term insurance, is usually the best way to go, as the need is not usually temporary.  Depending on the entire value of one’s estate, it may be advisable to have the life insurance owned by a trust rather than an individual. 

While life insurance is not income-taxable, the value of the insurance (i.e., the amount of the proceeds payable upon death), is part of one’s taxable estate.  Therefore, if one has a large estate and/or has a large amount of life insurance, then a trust should be considered.  Having the life insurance owned by a trust removes the value of the life insurance from one’s taxable estate, thus providing tax-free monies to one’s estate.  Ideally, the life insurance should be owned by the trust at the very outset, as transferring an existing policy to a trust is subject to a three-year look back–i.e., if one dies within three years of the transfer, the value of the insurance falls back into one’s estate. Once again, the proceeds from the life insurance would be available to the trust to cover taxes and other administration expenses, thus providing liquidity to one’s estate.

Of course, a life insurance trust, also commonly referred to an ILIT, must be drafted properly and the estate planning attorney and life insurance agent should work together in ensuring that the proper procedures are followed.