When planning for the future, many people see the finish line as the happy day when they retire. However, in reality, this is only the beginning. Estate planning can be a difficult process if plans are not made before retirement. Discussing all possible solutions to keeping more of your money to pass on to loved ones, family, and heirs should be done with a highly qualified financial consultant.
Some Common Misconceptions
Many people believe that if they work hard and invest wisely, their heirs will be left with a large portion of their estate. Unfortunately, the federal government can take up to 40% of the value of the estate and administrative costs can add another 5% reduction. Keeping more of an estate to pass on to loved ones should be the goal for anyone who has been successful with investments or business and wants to leave more assets to their heirs.
The transfer tax placed on an estate’s value by the federal government at the time a person dies must be paid in cash within 9 months of the person’s death. This can leave families scrambling for liquid assets to pay the large estate tax. If assets have to be liquidated quickly, often they are not sold for the full value of the asset, even resulting in pennies on the dollar returns. This not only decreases the overall value of the estate, but leaves heirs with less overall assets, but still paying the estate tax at a higher rate.
Potential Solutions to Pay Estate Taxes
Some solutions to paying the looming estate taxes include:
- 100% Method – accumulating enough cash beforehand to pay the estate tax is counterproductive to many people who use investments to increase overall wealth.
- 100% Plus Method – this entails borrowing the money against the value of the estate after the death of the estate owner. This is also counterproductive to many because of the interest that must be paid back along with decreasing the overall value of the estate.
- Forced Liquidation Method – the least productive of all of the ways to pay estate taxes. This process involves liquidating assets quickly, often resulting in pennies on the dollar returns.
- Discount Method – With enough preplanning, estate taxes can be paid with life insurance dollars. On average, people who use this method only pay one to seven cents yearly on every dollar of life insurance paid out. This method also allows for the life insurance policy to be structured to accommodate anyone’s unique premium payment requirements.
Benefits and Features of Life Insurance in Estate Planning
In addition to the bonus of providing a source of estate liquidity, life insurance also provides other advantages, such as:
- Prompt and Certain Payment – Life insurance proceeds are not subject to the time and expense of the probate process.
- Death of the Estate Owner – This event also creates a source of cash exactly when needed. The life insurance policy provides the cash for the certain need of estate settlement costs that often come at an uncertain time.
- Proceeds That Are Free of Income Tax – If the death benefit exceeds the total amount of premiums paid, the gain is received income tax free.
- Time – The premium payments on the life insurance are spread out over time and not required in nine months.
- Avoidance of Problems – Life insurance avoids all of the problems associated with the other methods for paying estate settlement costs.
- Policy Ownership – By giving up ownership of the life insurance policy, the proceeds collected may be estate tax free. The Irrevocable life insurance trust names an adult child or other person as the owner of the policy, thereby taking it out of the estate’s overall value.
For these reasons, the most economical, popular, and easiest method of providing the needed estate liquidity is life insurance.
What Should Be Done Now
Considerations for estate planning are relatively easy, but must be done before the death of the estate owner. In fact, the quicker a person purchases life insurance, the better off the estate will be when the owner dies.
- Depending on the situation, a detailed estate analysis or an analysis of the estate’s liquidity needs should be completed.
- Purchase the proper amount of life insurance to pay for the estate settlement costs.
- Put the insurance owner as an adult child or by an Irrevocable Life Insurance Trust. Both of these techniques allow the insurance proceeds to be kept out of the probate process if properly implemented.
- If using a survivorship policy for a spouse, the ownership of the life insurance should be retained in the estate owners name so that the insurance cash values can be used during the life of the estate owner if needed.
- When using a survivorship policy, if the spouse dies before the estate owner dies, the policy may be moved out of the estate by giving it away. However, if the estate owner dies within three years after the transfer, the proceeds will be included in the surviving spouse’s estate.
Short and Long-Term Considerations
In the short-term:
- Consult with an attorney to verify that an estate is arranged in a way to take the best advantage of the unlimited marital deduction. This allows estate taxes to be deferred until the death of the second spouse. Unified credit portability between spouses is also included.
- A thorough review of any current wills or trusts will help an attorney or financial advisor determine if these documents will operate as intended under both current and possible future estate and gift tax rules.
- A thorough review of the issued policy.
In the longer-term:
- Periodical review of all estate plans, wills, trusts, and life insurance should be conducted to ensure that these items continue to meet the needs and objectives of the estate owner.
- The unknown event of the death of the estate owner will dictate the amount of federal estate tax which will be determined by the size of the estate at death, the year the estate owner dies, and whether future actions by Congress will modify the estate tax rules.