Choosing the Right Life Insurance for Your Estate Planning Needs

By Richard A. McGrath, CIC, LIA

Life insurance has long been recognized as an ideal funding tool for estate planning, but it’s also important to choose the right life insurance policy for your estate planning needs.

One reason life insurance works so well is that the death benefit is paid out when the individual who owns the policy dies, making the funds available to heirs when the money is needed most.

Not everyone has the same needs and the first step before even considering the purchase of life insurance should be to define what your needs are. The benefit may be needed to pay taxes or other expenses, although death benefits from life insurance are typically exempt from federal income tax, and estate taxes can be avoided by transferring ownership of the policy to an irrevocable life insurance trust.

Some who are wealthy, such as business owners, have liquidity issues. The business may be worth millions, but businesses are illiquid; the only way to use a business to pay taxes is to sell it. The benefit from a life insurance policy can be used to pay taxes, preserving the business.

For others, the main concern may be wealth transfer, as it’s likely that you’d rather leave your wealth to your family. It can also be used to provide regular income for the surviving spouse after the death of the insured; policy proceeds can remain in the trust, keeping the assets out of the spouse’s taxable estate.

You may want to leave a financial legacy to your heirs or to a charity. A life insurance trust can also be used to distribute proceeds to children from a previous marriage, or to control income provided to children who may be financially irresponsible.

Making a Choice

Life insurance can help you address these issues, but how do you know which insurance policy meets your needs?

To begin with, it’s especially important to own life insurance that’s issued by a reputable carrier that is in sound financial condition. You want to be certain, of course, that the carrier is still in business as long as your policy is in force, so that your benefit will be paid out.

If you have life insurance with a guaranteed premium, the guarantee will last only as long as your insurer remains in business. Being older than you were when you initially purchased life insurance, you will likely pay more. If your health has deteriorated, you may even find it difficult to purchase coverage.

One way to check on the financial stability of your carrier is to check your carrier’s ratings with the major rating agencies for the insurance industry, which include A.M. Best, Fitch, Moody’s Investors Services, Standard & Poor’s and Thestreet.com (Weiss).

When choosing a life insurance policy, in almost all cases, you can rule out term insurance. You will need to buy cash-value life insurance – permanent life insurance – because it provides coverage throughout your life, as long as you do not cancel the policy and continue to pay your premiums. Term insurance provides protection for a specific period of time. If you outlive the term on your term life insurance policy, your beneficiary receives nothing.

Term life can still be used, though, to cover a short-term need. If for example, you expect to receive a buyout from a real estate investment in 10 years or you expect funds to become available from some other source, your insurance needs may be temporary and term life may be appropriate.

If you’re in a second marriage and have older children from your first marriage, consider having a separate life insurance policy for your older children, so they don’t have to wait for your second spouse to pass before they receive a benefit.

Types of Insurance

A good option for wealth transfer is a participating whole-life policy with increasing death benefits. Premiums can be based on annual gift tax exclusions and the insured can even include some of his or her gift tax credits in the policy.

Whole life insurance with increasing death benefits is most often the insurance of choice for use within a trust. With a whole life policy, the insurer generally invests cash-value funds in long-term, conservative investments that provide modest returns. The policy holder may also receive dividends, but they are not guaranteed. The policy holder has no control over how funds are invested, but premiums are guaranteed to remain at the same level.

Universal life is similarly conservative, but the insured can adjust premiums each year, based on his or her financial situation.

For those who are less risk averse and seek an opportunity to increase their cash value beyond what is available from a traditional whole life or variable life policy, variable life may be the preferable policy. With variable life insurance, the insured, rather than the insurance company, directs investments in stock and bond sub-accounts.

Finally, variable universal life combines the insurance protection of universal life insurance with the investment aspects of variable life. It allows policyholders, within certain guidelines, to design their own policies by increasing or decreasing their premium payments and by increasing or decreasing the policy death benefits. Increases in insurance do, however, require proof of insurability, and will trigger a recalculation of the surrender charge, as well as an increase in insurance charges. Decreases may also be subject to a surrender charge.

Variable universal life allows policyholders to make investment choices from sub-accounts within the policy. Typically these accounts provide a wide range of investment selections with various levels of risk and potential return. Policyholders usually can transfer funds between several different accounts at little or no charge several times a year.

Choosing which policy is right for you depends not only on your needs, but your level of tolerance for risk, your financial situation and other factors. Your independent insurance agent can help ensure that you have the policy that’s just right for your estate planning needs.


Richard A. McGrath, CIC, LIA is President and CEO of McGrath Insurance Group, Inc. of Sturbridge, Mass. He can be reached at rmcgrath@mcgrathinsurance.com.

This article is written for informational purposes only and should not be construed as providing legal advice.

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