Life Insurance's Role in Estate Plan

September 2001

By: Jay J. Lander, Esq.

Two primary goals of estate planning are to provide economic security to our dependents in the event of our deaths and to provide for the transfer of our accumulated wealth upon death to our family, while minimizing the estate tax cost of such transfer. Life insurance can play a major role in achieving both of these goals.

It is ironic that while most people will recognize the importance of estate planning, virtually no one agrees to buy life insurance without first being solicited by a life insurance salesperson. In fact many of us have developed a resistance to life insurance and consequently possess a degree of skepticism toward the industry and its products. It is this skepticism that may hinder an understanding of the importance of life insurance in many estate plans.

Many people do not realize that life insurance proceeds are includable in a decedent\'s gross estate for estate tax purposes, unless the decedent has not retained any incidents of ownership, such as the right to change the beneficiary or to borrow against the policy. Furthermore, life insurance proceeds are generally not considered taxable income to the recipient, unless the policy had previously been transferred for value to the beneficiary.

In all estate plans, the goal of providing economic security for our dependents in the event of death arises whenever a new family unit is created. When the primary wage earner has not yet been able to accumulate sufficient wealth, the purchase of life insurance payable to the spouse as primary beneficiary and to a revocable life insurance trust for the support and education of the children as a secondary beneficiary is desirable. The trust assures that the life insurance proceeds can be managed and invested to meet the educational and support needs of the children beyond the age of majority. A life insurance trust for the support and education of children becomes even more important for a divorced or widowed parent.

In larger estates where estate tax costs are relevant, life insurance can provide the liquidity that may be absent if the bulk of an estate is a family business or real estate. In order to avoid the necessity of a forced sale of the family business or real estate in a down market, life insurance should be maintained, if possible, at a level corresponding to the estimated estate tax liability.

Because the estate tax liability arises upon the death of the surviving spouse when no marital deduction is available, the joint life policy or \"second to die\" insurance has become very popular. These policies insure the lives of both spouses and pay the death benefit only upon the death of the second spouse. Because of this provision one is able to buy more coverage for less dollars. The joint policy does not, however, provide for the payment of insurance proceeds on the death of the first spouse, and therefore represents only a partial solution to one\'s estate planning needs.

Life insurance is often owned by someone other than the insured in order to remove the insurance proceeds from the taxable estate of the insured. A frequently recommended vehicle is the irrevocable life insurance trust, which would be the owner and beneficiary of the policy. Since the \"gift in contemplation of death\" rules still apply to the transfer of life insurance policies, it is preferable to have the trustee of the irrevocable life insurance trust own the policy from its inception. Such life insurance trusts must be carefully drafted to assure the exclusion of the insurance proceeds from the decedent\'s estate.

Finally, when you consider buying life insurance, the choice of the insurance company requires careful investigation, as well as what kind of insurance to buy; term or permanent, and how much coverage you need. In all of these matters, your estate planning attorney and your accountant are able to provide unbiased and objective advice.