Life insurance policies are powerful tools for estate planning, but their effectiveness depends on careful planning and consideration of your specific circumstances. Understanding the two common types of life insurance policies available and matching those with your needs and goals can create financial security for you and your family.
Life insurance provides a financial benefit to your beneficiaries when you die. There are two main types of life insurance: term life insurance and whole life insurance. Term life insurance provides coverage for a specific time period, while whole life insurance provides coverage for your entire lifetime and also builds up a cash value that you can borrow against or cash out.
Insurance Policies and Estate Planning
Life insurance policies can play a vital role in estate planning by offering strategic benefits, including:
- Providing Liquidity: Life insurance creates immediate cash for your beneficiaries, bypassing the probate process and offering quick access to funds for expenses like funeral costs, debts or ongoing bills. This can be especially helpful if your estate doesn’t have sufficient liquid assets readily available.
- Minimizing Estate Taxes: Life insurance proceeds received by beneficiaries are generally income tax-free and, depending on the policy structure, may also be exempt from state and federal estate taxes. This can significantly reduce the overall tax burden on your estate.
- Covering Specific Needs: You can designate specific beneficiaries for different policies, catering to individual needs. For example, one policy could provide funds for a child’s education, while another could support a spouse’s income or finance long-term care.
- Business Continuity: Key person insurance on a business owner’s life can protect the business in case of their death. The payout can replace lost income, facilitate ownership transition or prevent forced asset sales.
- Funding Trusts: Certain life insurance policies can be owned by an irrevocable trust, further shielding the proceeds from estate taxes and offering greater control over distribution to beneficiaries.
When to Re-Evaluate Insurance Policies
Life insurance needs are constantly evolving and regularly reevaluating your coverage ensures you have the right protection in place at the right price. There are a variety of life changes that could trigger the need to change a life insurance policy, including:
- Family Changes: Getting married, having children or losing a spouse can all create a need to increase your life insurance coverage or change beneficiary designations.
- Job Changes: A new job with different benefits or a change in salary could mean you need to adjust your coverage.
- Financial Changes: Paying off a mortgage or accumulating more assets may mean you can reduce or increase your life insurance coverage.
- Health Changes: A new diagnosis or ongoing health condition might mean you will have to pay more for life insurance as opposed to obtaining a policy when you are healthy.
- Increased Risk of Accidents: High-risk jobs, such as a police officer, carries a higher risk of injury and could justify adjusting your life insurance coverage.
In addition, it’s a good practice to review your insurance policies at renewal time to see if you’re still getting the best coverage for your needs and at the most competitive price. It can sometimes be a tricky balance between ensuring you’re neither underinsured nor overinsured.