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January 8, 2021 Article 3 min read

Life insurance can be an ideal tool for leaving an inheritance to those you care for — consider it an integral part of your financial and estate plan. Our experts unpack the benefits and how it works.

Elderly man playing with a kid in a living room.At its core, life insurance is a very simple concept. You pay a certain amount, typically on an annual basis, for a policy that will pay your designated beneficiaries a meaningful sum of money at your death. But just because people understand it doesn’t mean they like to talk about it. You see, the words “life insurance” often generate anxiety. In some cases, that’s because it’s associated with end of life; in others, it’s because of negative product experiences in the past. Whatever the reason, however, life insurance can be an ideal tool for leaving an inheritance to the people you care for. Failing to consider it as part of your financial plan can be a real missed opportunity. Let’s unpack that a bit.

Life insurance can be an ideal tool for leaving an inheritance to the people you care for.

Let’s start with term or “temporary” life insurance products.

The most inexpensive life insurance products are term life policies (either individual or group), also known as “temporary” policies. Term life policies are designed to last for a specific period, not for one’s entire life. It should be no surprise, then, that only a small percentage of term life insurance policies ever pay a death claim — nearly all eventually lapse. Term insurance is much like fire, auto, and medical insurance — you pay purely for the protection with no cash value accumulation. Although term life can, and in some instances will, leave an inheritance, a longer-term solution should be considered if this is the ultimate goal.

That’s where permanent life insurance products come in.

Where term life insurance is designed to last for a specific period, permanent life insurance can be designed to last for one’s entire life, ensuring an inheritance for the next generation. There are many types of permanent life insurance products, the details of which are beyond the scope of this piece. But regardless of the specific product type, a properly designed and monitored permanent life insurance policy will ensure a death claim is ultimately paid and that your beneficiaries are provided an inheritance.

Permanent life insurance addresses several inheritance-related matters:

  • Potential for an attractive rate of return: Upon the insured’s death, the proceeds paid to beneficiaries aren’t subject to income tax. When taking into account premiums paid relative to the tax-free proceeds received at death, the potential economics, as defined by the internal rate of return (IRR), can be quite attractive relative to other investment options. As you might imagine, the IRR can be significant if one dies prior to reaching life expectancy. Of course, the longer one lives the lower the IRR.
  • Tax-deferred growth potential: Besides tax-free death benefit protection, permanent life insurance may include a cash value element, which accumulates on a tax-deferred basis. The insured can access the cash value via loans or withdrawals. Or, if the cash value is left to accumulate within the policy, the death benefit may increase, leaving a larger inheritance for heirs.
  • Estate tax-free: As of January 2021, any individual estate in excess of $11,700,000 is subject to estate tax at death ($23,400,000 for a married couple). For those estates exceeding that amount, the excess is taxed at 40%, which would result in heirs receiving a smaller inheritance.  The lifetime transfer of assets out of one’s estate using various methods can significantly mitigate the impact of the estate tax. Life insurance is one of those methods. When properly structured in an irrevocable trust, life insurance proceeds can be distributed to heirs free of income, estate, and gift tax.
  • Liquidity: At death, life insurance proceeds are quickly available to heirs to cover immediate expenses, settlement, and other costs, which may include estate and income taxes associated with other assets. Families often rely on the liquidity to preserve assets for future generations that may otherwise need to be liquidated to pay these types of expenses.

Life insurance can provide useful inheritance benefits.

About 60% of all people in the United States were covered by some type of life insurance in 2018, according to the Life Insurance Marketing and Research Association (LIMRA) 2018 Insurance Barometer Study. That’s because, if purchased and structured properly, it can provide useful inheritance benefits regardless of when death occurs and should be considered an important part of one’s overall financial and estate planning strategy.

If you have life insurance related questions, please give us a call.

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