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Late-in-Life Insurance

Life insurance can be more than just a way to guard against the unexpected. For those with significant assets, it can also help solve complex estate-planning challenges.

The broad case for life insurance is well-known: Those in the prime of life can use it to help beneficiaries replace lost income, settle debts or achieve other financial goals should the insured pass away prematurely. But for those with large estates, there are other potential uses.

“Life insurance can be a creative, tax-efficient way to provide for your family if you have a large estate with specific requirements as to how your assets are to be distributed,” says Nancy Murphy, a Schwab senior financial planner in Indianapolis.

Specifically, life insurance can be used to:

  • Pay federal and/or state estate taxes.
  • Settle an estate with an  illiquid asset.
  • Provide for multiple heirs in blended families.
  • Establish a charitable giving plan while also providing for your beneficiaries.


While by no means exhaustive, these examples are meant to show how you can work with attorneys, financial planners and tax professionals to incorporate life insurance as part of your estate plan, when appropriate.

Estate taxes

For those estates that exceed the federal estate tax exemption—$11.2 million for individuals and $22.4 million for married couples in 2018—earmarking life insurance proceeds to cover federal estate taxes can be a prudent strategy. However, even smaller estates may face taxation for two reasons:

  1. Seventeen states and the District of Columbia impose estate and/or inheritance taxes (see “States that impose taxes,” below).
  2. Although the federal estate tax exemption was doubled under the Tax Cuts and Jobs Act of 2017, that provision is set to expire at the end of 2025, at which point the limits could come back down.


While it’s possible Congress could extend or make permanent the new exemption limits, wealthier individuals should still consult a tax professional to understand how current and future estate tax rates could affect their plans.

States that impose taxes

Twelve states and the District of Columbia impose an estate tax (which is levied on the decedent’s assets before they’re disbursed), and six states impose an inheritance tax (which is levied on inherited assets after they’re disbursed). Marylanders pay both.

State

Estate tax rate

 Estate tax exemption

Inheritance tax rate

Connecticut

7.2–12%

$2.6 million

n/a

District of Columbia

6.4–16%

$11.2 million

n/a

Hawaii

10–15.7%

$11.2 million

n/a

Illinois

0.8–16%

$4 million

n/a

Iowa

n/a

0–15%

Kentucky

n/a

0–16%

Maine

8–12%

$5.6 million

n/a

Maryland

16%

$4 million

0–10%

Massachusetts

0.8–16%

$1 million

n/a

Minnesota

13–16%

$2.4 million

n/a

Nebraska

n/a

1–18%

New Jersey

n/a

0–16%

New York

3.06–16%

$5.25 million

n/a

Oregon

10–16%

$1 million

n/a

Pennsylvania

n/a

0–15%

Rhode Island

0.8–16%

$1.54 million

n/a

Vermont

16%

$2.75 million

n/a

Washington

10–20%

$2.19 million

n/a

Source: Taxfoundation.org. Tax rates and exemptions listed are for the 2018 tax year. Inheritance taxes are levied on the posthumous transfer of assets and will vary based on the inheritor’s relationship to the decedent.

Illiquid assets

Families with a complicated or relatively illiquid estate—one that includes a business or real estate holdings, for example—may have a particular interest in using life insurance to generate cash flow for heirs while the estate is being settled.

“Say you have an apartment building or a family business as part of the estate,” Nancy says. “Life insurance can provide immediate liquidity so the family isn’t forced to borrow or sell to cover estate taxes, operating expenses or other cash needs.”

Death benefits from life insurance aren’t subject to income tax, but they may be subject to estate taxes if they are included in the value of the estate. One way to avoid such a scenario is to work with an attorney to establish an irrevocable life insurance trust.1

Blended families

Life insurance can also help provide for multiple heirs in a blended family. For example, someone in a second marriage with children from a previous relationship might be concerned that having her or his estate pass first to the new spouse could cause tensions within the family.

In such instances, a life insurance policy can provide an immediate payout to the children from the first marriage, without their having to wait for the remainder of the estate upon the stepparent’s passing.

“That’s just one way life insurance can be used to equalize an estate and create goodwill,” Nancy says.

Charitable giving

Life insurance may also be an option for those who wish to provide for their heirs but also establish a charitable-giving plan. Here’s one example of how it might work:

  1. An individual who doesn’t need to tap a tax-deferred retirement account for income uses the required minimum distributions the IRS mandates from such accounts starting at age 70½ to pay the premiums on a life insurance policy that will benefit her or his heirs.
  2. The individual then names a charity as the sole beneficiary of the retirement account.
  3. Upon the individual’s passing, the heirs receive the insurance policy’s death benefit while the charity receives the remaining assets in the retirement account.
     

This kind of strategy can also yield tax benefits. While the remaining assets in the retirement account would be included in the taxable value of the estate, the estate might also receive a tax deduction for its charitable gift.

Planning ahead

Such strategies may not make sense for every estate, but they can be effective in addressing particular challenges.

If you do decide to deploy life insurance as part of your estate plan, don’t wait too long to buy it. “As a person ages, their life expectancy decreases, which will have a significant impact on the insurance premium—not to mention the ability to secure a policy,” says Mark Porcelli, a Schwab senior financial planner in New York City. “As such, the earlier you purchase a policy, the more affordable it’s likely to be.”

1To be considered separate from the gross estate, existing policies must be gifted to an ILIT and the insured must live at least three years beyond the gift date.

What You Can Do Next

  • Charles Schwab works with Small Business Insurance Agency, Inc., to make insurance available. Call 888-539-4888 to speak with an insurance specialist today.
  • Find more estate-planning strategies.
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Important Disclosures:

Charles Schwab & Co., Inc., in association with Small Business Insurance Agency (SBIA), provides customers with access to life insurance issued by respected life insurance companies. Charles Schwab & Co., Inc. and SBIA are not affiliated. Both are licensed insurance agencies. Not available in all states.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

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