Life insurance can play a significant role in your estate plan as it provides a solution to a wide range of potential objectives. In general, life insurance serves one of two purposes: either to create an estate for your heirs or preserve your existing estate. Generally, life insurance premiums are not tax deductible but the benefit paid to the estate (probate may apply) or a beneficiary (probate would not apply) is also not subject to income tax. Common uses of insurance include:
- Provide liquidity in an estate to pay off liabilities such as taxes or mortgages. This will ensure that non-liquid assets, such as a cottage or business, do not have to be sold, but can be left to your beneficiaries.
- Establish a fund to provide income for an individual you wish to support, such as your spouse, children or grandchildren.
- To make a donation to charity.
Basic Types of Life Insurance: Term and Permanent
Term insurance provides protection for a specific period of time. It pays out the benefit only if you die during the term of coverage. Term insurance is typically used to fund a short-term estate need such as paying off an outstanding mortgage, protecting the estate against an immediate shortfall or to prevent financial hardship by replacing lost income caused by the death of the life insured.
This coverage is usually offered as a five-, 10- or 20-year term after which time it may be possible to renew the policy at a new premium rate. This coverage is generally the cheapest coverage to purchase if it will only be necessary for a short duration. If the coverage will be required for a longer period it may be less expensive to consider permanent insurance options.
Term to 100
Term to 100 coverage provides long-term protection in your estate plan. This type of Life Insurance coverage often has a constant annual premium throughout your lifetime with the annual premium being higher than that charged for a five-or 10-year term policy. This policy will remain in force as long as you pay the annual premiums, but if the premiums stop so does the coverage. This policy has no cash value.
Permanent insurance provides protection for your lifetime. As long as you pay the premiums, the death benefit will be paid. The majority of these types of products have a cash value or cash-surrender value.
Whole life coverage is similar to Term to 100 coverage in that it is intended to remain in effect for your lifetime. In addition to the permanent insurance coverage, a whole life policy also includes a savings component. Therefore, the annual premiums you pay fund the insurance premium with the excess accumulated for the future benefit of you or your estate. Over a period of time the policy's savings component will result in the accumulation of a cash value to the policy (referred to as a cash surrender value).
A universal life policy is a combination of term insurance and a tax-deferred saving's component. Your premiums fund the insurance coverage with the balance invested in various investment options that you select. The premiums can be increased to raise the amount of tax-deferred savings (with some limitations) or reduced to simply cover the cost of the insurance coverage. Premiums
may be suspended if sufficient cash value has been accumulated in the policy to fund the insurance coverage.
Insurance for Estate Planning Purposes
The use of Universal or Whole life insurance products rather than term insurance is the preferred option where the purchase of insurance is for estate purposes. Examples include having a life insurance policy that would cover estate taxes on death (capital gains generated due to the deemed disposition rules) or the ability to leave bequests without the advent of taxes payable.
As with all insurance products that are geared towards estate planning purposes, a thorough cost-benefit analysis should be performed in order to assess the appropriateness of the strategy.
How much Insurance is enough?
The amount of coverage you require will depend on your estate objectives and current financial status. As you age, you may find that the level of coverage you require declines or perhaps changes from short-term to permanent coverage. Determining exactly how much and what type of insurance is most suitable for your situation can be best assessed through the preparation of a financial plan and the aid of a life-licensed advisor_. The financial plan and a life-licensed advisor_ can help you in the determination of both short-and long-term needs in conjunction with your overall financial objectives.