The Use Of Life Insurance In Estate Planning

The life insurance policy has often been called the “poor man’s will” because it specifies the beneficiaries as well as how the benefits are to be paid. It is a particularly valuable estate asset because it is the only one which is guaranteed to have a higher value at the death of the insured than at any time during his life. Life insurance is also valuable because the policy proceeds are paid promptly and in cash. This permits the executor to pay various estate liabilities quickly thereby removing the need to sell any properties at inopportune times. 

Besides providing liquidity, life insurance also helps achieve the other three principal objectives of estate planning. By assuring his family of adequate resources for living after his death, the estate owner can use the remainder of his income and property as the family wishes without fear of future catastrophes. 

Since life insurance proceeds are not subject to intestate laws, such proceeds are paid to beneficiaries designated by the policyholder. Thus, even if the insured has no will, he can be sure that at least a part of his estate will be distributed according to his wishes. The use of life insurance in the estate can reduce both administrative and estate-transfer costs. If the beneficiary is someone other than the estate, the use of life insurance proceeds avoids both the time and cost of probate. Texas exempts from inheritance taxes the first $40,000 of life insurance proceeds paid to certain named beneficiaries. Furthermore, proceeds are subject neither to income taxes nor to capital gains taxes if paid in a lump sum. If paid in installments, only the interest earned on the money left with the insurer is taxed, and there is a $1,000 per year exclusion on such interest if the proceeds are payable to the surviving spouse. Also, as long as premiums are being paid, increases in cash values are not taxed. However, similar increases in bank savings accounts would be taxed. 

The main decisions to be made regarding the use of life insurance in the estate plan involve the choice of beneficiary and the choice of policy options. If the estate is the beneficiary, then the proceeds must be probated with the remainder of the estate and do not escape the costs and delays of probate. Also, if the proceeds are probated, they are subject to contests of the will by disappointed heirs. For these reasons, adult children are sometimes made the owners of the policy. This action takes the proceeds completely out of the estate while providing heirs with the liquidity necessary to avoid forced sales of various estate assets. The procedure also transfers assets directly to the children, assuring their exclusion from the wife’s estate. 

The choice of settlement options must be made carefully and keyed to the particular circumstances. Much flexibility is permitted by the “at-interest” option if the beneficiary desires an option but wants to maintain the right to choose it at the insured’s death. If the beneficiary is a good financial planner and has other plans for the money, the lump sum could be taken. If the owner wishes to provide for a beneficiary who is relatively inept at handling family finances, he probably would choose one of the other options. 

The planning of life insurance in the estate plan must also consider the benefits provided under the government-sponsored Social Security program.