Although life insurance is one of the most overlooked and misunderstood elements in financial planning, it can be a valuable tool for wealth transfer if integrated properly.
1. You no longer need the type of insurance you have.
Imagine a married couple who bought a house and needed life insurance to protect their home and future earnings in the event of a loss. Many people buy life insurance too early in their lives and then forget to review their coverage later on if their financial outlook and situation changes.
If your health has deteriorated, the term insurance you purchased when you were younger may still be an option. Most term policies can be converted into a permanent policy (such as whole) within a specified time period and without additional medical examination. This will allow you to increase your monthly premium. If you are looking to retain your coverage while locking in a rate, this can be a good option. Let’s suppose that the forgotten policy was a permanent policy that had a high cash value and a substantial death benefit. If ownership were in the taxable estate, beneficiaries would not receive the full benefit. You would be in a taxed situation (over the exemption from estate taxes) which may have been different when you purchased the policy.
2. The policy ownership doesn’t align to your estate goals.
Sometimes clients’ whole lives or universal policies have a large cash value. These policies are owned in the client’s taxable estate instead of being held in trust. Although the death benefit of a term policy may not be subject to income taxes, beneficiaries will still be able to receive it even if it has no cash value. However, estate taxes will apply to policies that are owned within the estate.
Most people don’t think about their future taxable estate when they buy life insurance policies. People also mistakenly assume that life insurance is exempt from estate taxes. Deferred compensation, stock options and IRAs can all be included in an individual’s estate. These assets could include stocks, stock options and retirement plans, pensions. 401(k),s and profit sharing. Investments, real estate, cash and jewelry are also possible. If you include a life insurance death benefit that can easily reach $5, $10, or $20 million, it is possible to exceed the federal estate tax exemption (11.4 million for individuals, $22.8 million for married couples). Keep in mind, however, that exemption limits for estate taxes can vary between states.
3. Insurance is held in trust but poorly administered.
The trustee must perform administrative tasks if your life insurance policy is held in trust. This includes setting up a bank account for premium payments and sending monthly statements to beneficiaries. Trustees often fail to give Crummey notices of gift to beneficiaries. This is one of the most common mistakes. Crummey notices give detailed and timely instructions to beneficiaries on how they can exercise their right to withdraw the money. This is true even if the money was intended for paying premiums. Crummey notices are deemed present interest gifts and the funds can be accessed immediately by beneficiaries without restrictions. Although the beneficiaries may not withdraw these funds, they must be notified. Sometimes, just sending the notice suffices and works under negative consent. This means that no action is required by the beneficiary. However, failure to send the notice when gifts are made qualifies them as future interest gifts and is considered part of the grantor’s estate and could jeopardize the trust’s purpose.
Consumers should take these key points into consideration: It is crucial to work closely with an attorney when creating a trust. This will ensure that your intentions are supported and allow you to name a competent trustee to manage it. The trust could be run into IRS regulations if the trustee isn’t attentive for the first few years. It’s important to note that the likelihood of the grantor passing away increases with time. The IRS will examine your estate for the most recent year.