Planning for the future is one of the most important parts of securing your family’s financial well-being. Life insurance can be used as a valuable tool for your estate planning. It can help you and your beneficiaries manage taxes, and make sure that your loved ones are taken care of when you’re no longer there to support them.

Life insurance doesn’t need to be used only for immediate expenses. It can be a key part of your overall estate plan and can be used to protect your family’s assets. Here are four ways life insurance can be used in your estate planning.

1. Providing Immediate Liquidity for Estate Taxes

When someone passes away, their estate may owe taxes before any assets can be transferred to their heirs. These taxes, especially for larger estates, can be significant. They also usually need to be paid within a relatively short period of time. Life insurance can be an effective way to provide the necessary funds to cover these taxes without placing a financial burden on your beneficiaries.

How Life Insurance Can Cover Estate Taxes

Estate taxes are charges imposed by the government on the value of your estate after you die. The exact amount will depend on the size of your estate and the specific inheritance tax laws in your state. For sizable estates, these taxes can take a significant portion of the assets you’ve worked hard to accumulate.

Your heirs might not have enough cash readily available to pay these taxes. In many cases, most of an estate’s value remains tied up in non-liquid assets like family businesses, real estate long-term investments, or valuable personal property. Without sufficient liquid cash on hand, your loved ones may struggle to settle this tax bill.

By purchasing a life insurance policy with a death benefit that matches your potential estate tax liability, you can ensure that those funds will be available immediately upon your death. The life insurance payout is generally made quickly and can then be used by your beneficiaries to pay the necessary taxes.

Preventing the Forced Sale of Assets to Pay Taxes

Without enough liquid assets to cover estate taxes, your beneficiaries might be forced to sell assets quickly to raise the necessary funds. This situation can lead to several problems. In a rush to meet tax deadlines, your heirs might have to sell properties or investments at prices lower than their true market value. Quick sales often result in less favorable terms.

Important family properties, like a home that’s been in the family for generations, might have to be sold. If a family-owned business needs to be sold to pay taxes, it could result in job losses for employees and the end of a legacy you’ve built over the years.

Using life insurance to cover estate taxes helps prevent these issues. The death benefit provides the necessary cash, so your heirs don’t have to sell assets under pressure. They can retain properties, businesses, and investments, preserving your family’s heritage.

2. Equalize Inheritances Among Beneficiaries

When planning your estate, you may find it difficult to divide your assets fairly among your heirs. This can be especially difficult when your estate includes valuable items that can’t be easily split, like a family business, a farm, or a cherished piece of real estate. Some assets carry sentimental value or are inherently indivisible. Life insurance can help balance what you end up giving to your heirs.

For example, if you have a family business and two children it can be difficult to decide what to leave to each one. Imagine that one of your children has been actively involved in your family business and is interested in taking it over. The other child has pursued a different career path and isn’t connected to the business. The business represents a significant portion of your estate’s value, and you want to pass it on to the child who will continue running it. However, you also want to provide for your other child in a way that feels fair.

If you purchase a life insurance policy with a death benefit that matches the value of the business, you can name the child who is not involved in the business as the beneficiary of the policy. Upon your passing, one child inherits the business, and the other receives the life insurance proceeds. This way you can both distribute your wealth the way you would like and treat both children fairly.

If you want to use a life insurance policy in this way, you might need to hire professional appraisers, especially for items like real estate, businesses or valuable collections, so you can get precise valuations.

If you clearly outline your intentions and provide equal value to each beneficiary, you decrease the chances of a dispute occurring between your heirs. Everyone can understand what your plan is and can feel they have been treated fairly. You also get to keep valuable or sentimental assets within the family without forcing a sale or division.

3. Protect and Preserve Family Wealth

Life insurance can be used as a safeguard for the wealth you’ve accumulated. A life insurance policy can shield your estate from unexpected expenses that might arise after your passing. Life insurance guarantees that funds will be available to cover costs like debts, taxes, or other obligations without selling assets you wish to pass on.

The funds from the benefit can be used to pay for funeral costs and administrative expenses related to settling the estate. Funerals and other end-of-life expenses can add up quickly. Having cash on hand from a life insurance benefit can ease this burden.

Permanent life insurance policies are designed to last your entire lifetime as long as premiums are paid. These policies will also accumulate cash value over time. This cash value grows tax-deferred, which means you won’t pay taxes on any interest until the money is withdrawn.

A policy’s cash value can be used to preserve your wealth while you are still alive. You can access the cash value during your lifetime through loans or withdrawals, which gives you a source of funds for emergencies without selling assets.

4. Fund Charitable Giving and Legacy Projects

Life insurance can be a powerful tool for supporting charitable organizations and causes that are important to you.

One way to support a charity is to name the organization as a beneficiary of your life insurance policy. This means that upon your passing, the death benefit goes directly to the charity. This lets you make a substantial donation to the charity without affecting your current finances. You continue to own the policy and pay the premiums, but the charity receives the benefit when the time comes. Your estate may also be able to claim a charitable tax deduction for the proceeds given to the charity.

Another way to use life insurance in charitable giving is to transfer the ownership of the life insurance policy itself to the charity. When you transfer the ownership of the policy, the charity becomes the beneficiary, but can also choose to surrender the policy and receive the cash value. What’s more, a charity will usually be able to receive the full cash value, since public charities are tax-exempt. If you surrendered the policy yourself and then gave the money to charity, you would have to include it in your tax return. If you give your life insurance policy to charity you may then be able to claim a current-year tax deduction for the contribution.

You could also gift your life insurance policy to a donor-advised fund. A donor-advised fund is a fund that qualifies as a charity and can surrender your policy tax-free to extract the cash value. You then recommend what charities and investments the money should go to. Returns from investments in the fund can be contributed according to your recommendations before and after your passing.

There is one more tax advantage of transferring ownership of your life insurance policy to a charity or donor-advised fund. Since the life insurance policy is no longer part of your estate, transferring ownership of the policy lowers the overall value of your estate for tax purposes. This means your heirs might face fewer estate taxes, allowing more of your assets to pass on to them.

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Making Life Insurance Part of Your Estate Planning

Here are some things you should consider when deciding how to make life insurance a part of your estate plan.

Term Life vs. Permanent Life Insurance

There are two main types of life insurance policies: term life and permanent life insurance.

Term life insurance provides coverage for a specific period, such as 10, 20 or 30 years. If you pass away during this term, your beneficiaries receive the death benefit. These policies are usually less expensive and are a good fit if you only want coverage for a certain time frame. For example, you may want to be covered by a life insurance policy until your mortgage is paid off or your children are grown.

Permanent life insurance offers coverage for your entire lifetime as long as premiums are paid. Since permanent life insurance doesn’t expire, it’s usually the choice for those who want to include a life insurance policy in their estate planning.

Should You Set Up a Trust?

Estate taxes are levied on the value of your assets when you pass away. Life insurance proceeds can increase the size of your estate if you own the policy at the time of your death, which can lead to higher estate taxes.

However, there are some strategies which can be used to minimize this burden. One approach is to transfer ownership of your life insurance policy to someone else or to a trust. By doing so, the death benefit is not included in your taxable estate, reducing the estate taxes your beneficiaries might owe.

Setting up an irrevocable life insurance trust can help with this. An ILIT is a trust that owns your life insurance policy. By placing the policy in an ILIT, you remove it from your taxable estate. This means the death benefit passes to your beneficiaries without increasing estate taxes.

The trust is created while you are still alive, and you will need to name a trustee who will manage it. The trustee is responsible for administering the trust according to your instructions. This means managing the life insurance policy and distributing proceeds after your death. The trustee must handle tasks like paying premiums, keeping records, and communicating with beneficiaries.

You can select a family member, friend, or a professional trustee. Consider someone who is trustworthy, financially savvy, and willing to take on the responsibilities involved.

The trust will either purchase a life insurance policy on your life, or you can transfer an existing policy into the trust. Since you no longer own the policy, the proceeds are no longer part of your estate.

An ILIT allows you to set specific terms for how the death benefit is used. For example, you can direct funds to pay estate taxes, support a surviving spouse, or provide for education expenses. Setting up an ILIT requires careful planning. Once established, the trust cannot be changed or revoked.

Income Taxes on Life Insurance Benefits

Life insurance payouts are generally received by beneficiaries tax-free. However, certain situations might make the proceeds taxable.

If the policy was transferred for something of value the death benefit could become subject to income tax, because of something known as the “transfer-for-value” rule. To avoid this, it’s important to structure policy ownership and beneficiary designations properly. A professional can help with this.

Working with Professionals

Planning an estate can be a complex process, so it is often advisable to enlist the help of professionals. Financial advisors and estate planners have the expertise to help you navigate the options available to you and make sure that your estate plan gives you the results you want.

Financial advisors can assess your unique situation and recommend the right life insurance strategy for your needs. They can help you understand the exact differences between policy types and figure out which one will work best for what you are trying to do.

Estate planners focus on the legal aspects of transferring your assets to your heirs. They can help you draft wills, trusts, and other legal documents that ensure your wishes are carried out.

These professionals keep up-to-date on the latest laws and regulations. With their help, you can know for sure that your plan is legal and won’t cause any problems for your heirs and beneficiaries. They can save you time and help you avoid costly mistakes that might come from trying to manage everything on your own.

Next Steps

Taking the time to plan now allows you to create an impact that will reflect your values and priorities. Whether it’s preserving a family business, supporting a cherished cause, or making sure your heirs are treated fairly, life insurance offers you the tools you need to get what you want out of your estate planning.

Here at Fidelity Life, we’re committed to supporting you each step of the way, providing different insurance options for every age and stage. Start your quote online or give one of our agents a call at 1-866-941-651 to find the right policy for you.

At Fidelity Life, our goal is to make life insurance simple, affordable, and understandable for everyday families. This content is intended for educational purposes only. Each post is carefully fact-checked, reviewed, and updated regularly to ensure the information is as relevant as possible. We encourage you to speak with your insurance representative if you have additional questions and make sure you read your policy contract to fully understand your coverage.