Life insurance has long been a part of estate planning in the United States. Although life insurance doesn"t need to be a part of every person's estate plan, it can be useful, especially for parents of young children and those who support a spouse or a disabled adult or child.
In addition to helping to support dependents, life insurance can help provide immediate cash at death. Insurance proceeds are a handy source of cash to pay the deceased's debts, funeral expenses, and income or estate taxes.
People who have no minor children or financially strapped dependents might not need life insurance. Below you'll find questions to ask yourself to help evaluate your life insurance needs. If you decide to purchase insurance, you should know exactly why you are buying it and choose the best type of policy for your needs. And, of course, you should buy no more than you need.
To determine whether it makes sense for you to buy insurance to provide financial help for family members over the long term, consider these questions:
Once you perform this exercise, you could find that your dependents might need little additional income from life insurance. But if you have young children, you could find that it makes sense to buy an affordable amount of life insurance.
Now, assess whether you need life insurance for short-term needs:
The proceeds of a life insurance policy aren't subject to probate unless you name your estate as the beneficiary of the policy. If anyone else, including a trust, is the beneficiary of the policy, the proceeds don't go through probate and can be quickly transferred to survivors with little red tape, cost, or delay. Except when your estate will have no ready cash to pay anticipated debts and taxes, there is no sound reason for naming your estate, rather than a person, as the beneficiary of your life insurance policy.
If you own your insurance policy at the time you die, the proceeds are included in your taxable estate. If your estate is large enough to face estate tax liability, your life insurance proceeds will be subject to estate tax. On the other hand, if you don't legally own your life insurance policy, the proceeds are excluded from your taxable estate. This can significantly reduce your death tax liability.
If you are the sole owner of a business, how much cash will it need when you die? Do you want and expect that some of your inheritors will continue the business? If so, do you think there will be enough cash flow for them to successfully maintain the business? You might need insurance proceeds to cover any cash flow shortage of the business. Will there be liquid funds to pay estate taxes?
Example. Alicia owns several valuable pieces of real estate and a profitable antique store, but she has very little cash and no life insurance. When she dies, she owes debts of $90,000 (aside from mortgages) and estate taxes of $120,000. To raise this money, her beneficiaries (technically, her executor) must sell some of her real estate or her interest in the store. Unfortunately, the country is suffering a recession, and the market value of both antiques and real estate is down. To make matters worse, canny real estate people spread the word that this is a "distress sale" to raise money for estate obligations. As a result, the price the beneficiaries receive when they sell one of the pieces of real estate is far below what they would have received had they been able to choose when to sell. Had Alicia purchased an insurance policy with a payoff at death of $210,000 or more, they wouldn't have been forced to sell.
If your inheritors won't continue the business, the questions are different: How much is your death likely to affect the value of the business? Will there be enough cash to keep the business alive until it is sold?
If you are one of several co-owners, life insurance proceeds can be used to buy out co-owners' interests. For more information on using life insurance to fund buyouts, see Business Buyout Agreements, by Anthony Mancuso and Bethany K. Laurence (Nolo).
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