Life insurance is a very important part in estate planning, also known as legacy planning. The payout from a life insurance policy can be used to leave an inheritance, settle a buy-sell agreement for your business, pay your final expenses, or to reduce and/or settle your estate taxes with the IRS when you pass away. Depending on the size of your estate, estate planning with life insurance can be vital to ensuring your heirs are able to retain the assets you have worked for.
Estate planning is for everyone
Estate planning is not just for “retired” people. Most of us think about it as we get older. We can’t however, successfully predict how long we will live, illnesses and accidents or how long we will live.
What happens when you don’t have a plan
If you become disabled, and your name is on the title of your assets, only a court appointee can sign for you as you can’t conduct business due to mental or physical incapacity. The court will control how your assets are used to care for you through a conservatorship or guardianship, not your family. This is often an expensive process that can be difficult to end even if you recover.
If you pass away without an estate plan, your assets will be distributed according to the probate laws in your state. If you are married with children, your spouse and children will each receive a share. In some cases your spouse could receive only a fraction of your estate, which may not be enough to live on. The court will control the inheritance of your minor children. If both parents die, the court will appoint a guardian without knowing whom you would have chosen
Estate Planning Life Insurance Trusts
Depending on the size of your estate, estate planning with life insurance can be vital to ensuring your heirs are able to retain the assets you have worked for. Here are the differences between a revocable life insurance trust and an irrevocable life insurance trust.
Revocable Life Insurance Trust:
A revocable life insurance trust allows the owner of the life insurance policy to maintain control and ownership of their life insurance policy, a “revocable trust” can be revoked or changed at any time if your needs change. However, because of the flexibility in these types of trusts, they do not carry the same tax advantages. If your life insurance policy is owned by a revocable trust, it will be included in the total value of your estate and it the payout could be subject to estate taxes. These types of trusts are more ideal for younger families with smaller estates. They are not designed to avoid any potential estate tax obligations.
Irrevocable Life Insurance Trust:
An irrevocable life insurance trust(ILIT) separates the life insurance policy payout from the estate of the insured and his or her spouse to reduce or avoid estate taxes. When an ILIT separates the policy from your estate, you lose complete control or your life insurance, but your eliminate your tax liability. You can still control the proceeds of your estate and life insurance policy, but these wishes will be carried out by the trustee of your will when you have passed away. Commonly, clients will choose an attorney or an executive of their bank as the trustee of their ILIT. You can also name a family member as your trustee, if you elect to name a family member, be sure to pick someone who is responsible, honest, and good with managing finances.
When you pass away, the proceeds of a life insurance policy are paid to your trust, tax free. This money is the used to pay off any estate taxes owed to the IRS on your final estate. By settling these taxes with the proceeds of your life insurance policy, your estate can be passed on in accordance with the directions laid out in your trust. Your trustee will direct these transactions to ensure that your final wishes are carried out. For an irrevocable life insurance trust to function correctly, you must purchase a permanent life insurance policy.
Advance directives can ensure that your wishes for medical care in an emergency and at the end of life are expressed. Here are some examples:
Durable power of attorney — names the person who will make medical decisions for you if you cannot make them yourself.
Living will — records your wishes for medical treatment near the end of life. It describes what life-sustaining treatment you do or do not want if you are terminally ill, permanently unconscious, or in the final stage of a fatal illness.
Do-not-resuscitate (DNR) order, – instructions for health care providers not to perform cardiopulmonary resuscitation (CPR) or other life-support procedures if your heart stops or if you stop breathing.