If you have a family — especially if you have children — life insurance can be a very important part of building a financial plan. A life insurance policy costs a bit now, but in exchange you get peace of mind that your family will be taken care of if something unexpected happens to you. One thing a lot of people don’t consider, though, is that a life insurance policy can also be used as an effective way to protect assets. This strategy is especially useful for high-net-worth families, as it can help cover estate taxes and equalize inheritance levels amongst various heirs. Here’s what you need to know about how life insurance can bean asset protection strategy.
For more help with life insurance quandaries, consider working with a financial advisor.
Life Insurance Primer
Life insurance works the same way as other insurance products — you pay premiums to an insurance company in exchange for the promise of a payout in certain conditions; in the case of life insurance, the condition is your death, and the payout goes to your designated beneficiaries, most likely your family.
There are two basic types of life insurance: term and permanent. Term life insurance only lasts for a certain period of time, determined when you buy the policy. This type of insurance is advisable for those making sure a spouse will be able to take care of children in the event of their death. Permanent life insurance, meanwhile, lasts for as long as you keep paying the premiums. If your spouse earns significantly less than you and would need money to survive even if there aren’t minor children anymore, this policy might make more sense.
Within permanent life insurance, there is a subcategory known as whole life insurance. This type of policy takes some of the premiums paid to the insurance company and puts it into a cash value account. The money can grow tax-deferred and be borrowed while the policy holder is still alive.
Life Insurance and the Estate Tax
In cases where federal or state estate taxes are due, they are paid by the family of a recently deceased person before any money has been dispersed to heirs and other beneficiaries. The federal estate tax only applies to estates worth more than $12.06 million for single filers or $24.12 million for couples, but some states charge their own estate taxes, which could be levied on much smaller estates.
The estate tax is based on the total value of a person’s entire estate, not just the liquid assets. This could cause a problem for some families, as it isn’t always simple to liquidate assets; if the deceased didn’t hold a lot of cash, they may be in trouble.
A life insurance policy, though, will pay cold, hard cash. If you have a sense of what your estate tax burden will be, a life insurance plan with a payout near that total would simplify estate tax payments considerably.
Life Insurance and Asset Preservation
Setting up an irrevocable trust for life insurance is a strategy for protecting your assets. Here’s how to do it:
First, set up an irrevocable trust. This can be a bit tricky, so using a lawyer is recommended. You can then put cash into the trust to pay the premiums each year. Because the money is in the trust, it is technically no longer yours; it actually belongs to the trust. This protects the money from potential claimants while still being used to pay for a permanent whole life insurance policy.
The Bottom Line
Life insurance is a good investment, as it gives your family a cushion if something were to happen to you. Furthermore, a life insurance policy can be used as asset protection and to help with potential estate tax payments.
Life Insurance Tips
- For help with managing life insurance, consider working with a financial advisor. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Use SmartAsset’s free life insurance calculator to get a sense of how much insurance you’ll need.
Photo credit: ©iStock.com/Brothers91, ©iStock.com/DragonImages, ©iStock.com/Fly View Productions