Estate Planning with Life Insurance
Do I really need life insurance ?
While this question is better answered by your financial advisor - the short answer is generally yes, if you have others who are financially dependent upon you. In other words, if you died and your spouse and/or kids were relying on your income to stay afloat, then you would need life insurance to cover the shortfall until they can reach financial independence. That is why many people get life insurance policies with a death benefit to replace years of income (and maybe pay off all existing debts plus estimated college/education costs). Once again, this is a question best answered by your financial advisor, but that is the common practice (especially among my younger clients). Of course, if you already have millions in the bank, don’t need the liquidity, and/or have no one financially dependent upon you, then that answer will change.
Is Life Insurance Taxable?
One of the most common oversights in estate planning in Massachusetts is the tax on your life insurance proceeds. If you are thinking, “I thought there was no tax on life insurance proceeds” then you are partially correct. There is no income tax on life insurance proceeds, but there could still be an estate tax on such proceeds if your estate exceeds the state and/or federal estate tax threshold. In Massachusetts, this is a fairly easy target to hit because the current threshold is set to $1 million and does not adjust for inflation. In other words, if you own a home, have a decent sized retirement account, and have a life insurance policy on top of that, then you are likely to be above that Massachusetts estate tax threshold. Fortunately, the federal estate tax exemption is very high ($11.7 million in 2021) so you likely don’t have to worry about federal estate tax exemption. But the Massachusetts estate tax can easily creep up on you, and the worst thing about that Massachusetts estate tax structure is that the entire amount, not just the amount above $1 million, is subject to estate tax if you pass that threshold. Reread that sentence one more time.
The different types of life insurance…
The four main types of life insurance are…
Term Life Insurance: This type of insurance policy is set for a predefined number of years (e.g., a term policy may last 10, 20, or 30 years) and provides your beneficiary a check when you die. Due to their simplicity, these policies tend to be cheaper and easier to navigate than the other options. In most cases, Term Life Insurance gives individuals the best value for their money by giving the biggest death benefit relative to its cost.
Whole Life Insurance: This type of insurance is also known as straight life, ordinary life, or permanent insurance. It covers you for as long as you live, but usually requires a larger up front premium. If you pay enough up front then it’s possible to cover future premiums with the amount generated on investments made inside the policy’s sub account. With this type of policy, the payments for premiums are usually the same each time and they vary based on factors such as your age and health at the time of purchasing the policy.
Universal Life Insurance: This type of insurance, also known as Flexible Premium Universal Life, allows you to be flexible when it comes to paying premiums. In other words, you generally have the option to raise your payments or lower your death benefits depending on your changing financial circumstances. The adaptive nature of this policy is what appeals to most who purchase it.
Variable Life Insurance: This type of insurance varies based on the performance of the investments inside the policies sub-accounts. Typically, individuals will be offered a variety of options for investments including: equity, bond, and money market mutual funds. There is a risk with this type of insurance policy - if the investments you choose depreciate or stagnate, then you may see that the value of your account go below the amounts you paid in. However, there may be additional riders that limit this downside risk. Once again, you will need to speak with your financial advisor to properly evaluate which option makes the most sense for you and your family.
Naming your beneficiaries...
Another common estate planning issue occurs if you forget to update your death beneficiary designations. When a person dies with life insurance, the death benefits paid on life insurance policies are automatically set to go to those persons named on the account. In other words, death benefits are often not paid to one’s estate, which means they wouldn’t pass in accordance with your Will. On most life insurance policies, the primary beneficiary is the first to receive the death benefit and is usually listed as “my spouse.” Contingent or secondary beneficiaries are generally listed as “equal shares to my children” with the option of “per stirpes” or “by right of representation” checked off. This common death beneficiary set up is designed to keep the proceeds within your immediate family bloodline.
Does life insurance avoid probate?
While most cases of life insurance proceeds do avoid probate, some don’t. For example, if the beneficiary is listed as “the estate of (your name)” then proceeds would have to be paid to the executor of the estate. Another example is when spouses name each other as primary beneficiary, but they fail to name a “contingent beneficiary” on the policy. In such scenario, without a contingent beneficiary named, the policy death benefits would be routed through probate and thereby pass in accordance with your Will.
Interested to learn more about how your life insurance may impact your estate? Give me a call (781) 202-6368 or email JLento@PerennialTrust.com.
I’m always happy to answer your questions.
Sincerely,
Joseph M. Lento, J.D.
Attorney & Owner of Perennial Estate Planning
Other helpful reading:
Carlson, Darren R. (2014). Your 1960S Tv Guide To Estate Planning. MOTIVATIONAL Press, INC.
