With the ability to generate funds quickly, life insurance can help reduce the burden of a family member’s death by eliminating debt and offering funds for ongoing expenses. So whether you just want to make sure the bills get paid—or you have more complicated goals, such as philanthropy or special needs planning—it’s worth knowing where life insurance might fit in.
What Is an Estate?
An estate consists of any property that you leave behind after death. When you’re alive, you have an ownership interest in real estate, financial assets, personal property, and other types of property. But when you die, any assets remaining under your control become part of your estate. An estate can also have debts. If you owe money to creditors when you die, your estate might need to pay off those loans (assuming there are sufficient assets to do so). Some loans, such as federal student loans, might be discharged at death, but other loans still require payment. When somebody dies, the estate often goes through a lengthy probate process. That process involves examining the will, appointing an executor for the estate, and completing other tasks to manage the decedent’s assets. For example, the administrator might sell property, pay any creditors, file taxes, distribute assets to heirs, and more.
Transfers at Death
Not all of your assets go to your estate. For instance, when you name a beneficiary on a life insurance policy, the death benefit generally goes directly to the beneficiary without going through your estate. Retirement accounts with a designated beneficiary are similar—the assets typically pass directly to beneficiaries. Likewise, property or accounts held in joint tenancy with rights of survivorship may automatically become the property of any surviving owners.
Why Life Insurance Is Important for Estate Planning
Making arrangements for loved ones after your death is an essential part of any estate plan. Life insurance policies can provide a substantial amount of money, and beneficiaries can use those funds for a variety of needs. For example, the money might be useful for paying off debts and preventing financial hardship for those you’ve left behind. Families that don’t have substantial liquid assets can address that issue with insurance. By paying premiums on life insurance policies, it’s possible to secure a future payout.
How Does Life Insurance Create an Immediate Estate?
A life insurance policy pays a specified amount of money when an insured person dies. Those funds can go to the decedent’s estate or to beneficiaries, providing financial relief and liquidity. The payout on a life insurance policy is often completed within two to four weeks, although the process may take longer should the insurance company have additional questions. When funds arrive quickly, survivors can stay current on payments, pay off debts, and budget for the future. The death benefit from a life insurance policy often comes in a lump sum or annuitized payments. While you don’t need to spend the entire lump sum immediately (it’s smart to make a long-term plan), you can put the entire amount to work right away. If the proceeds of a life insurance policy go to your estate, the executor or administrator can use those funds to address your final wishes and meet obligations. For example, if you owe money on a home, the executor can pay off that debt, enabling loved ones to keep the house. Any remaining assets can then be distributed according to your will or state law.
Benefits of an Immediate Estate
A lump sum of cash can be useful in various ways. Whether the funds help your loved ones avoid hardship or accomplish strategic goals, life insurance proceeds can provide flexibility.
Tax-Free Money
The death benefit from a life insurance policy is typically tax-free for beneficiaries. However, any interest you receive is taxable, and there may also be some exceptions, so check with a CPA. A tax-free source of funds maximizes the amount beneficiaries can spend on goals.
Provide for Loved Ones
A life insurance payout can provide financial security for loved ones. For instance, when a parent dies, a family might suddenly lose an income source, making it hard to pay bills. Plus, a surviving parent faces the burden of running a household and raising kids on their own. With extra money on hand, it may be possible to take more time off work or hire help.
Liquidity
A substantial lump sum of cash can help you keep your options open. For example, if you own assets that have gained value, selling those holdings to generate cash might have tax consequences. Alternatively, you could have to sell interests in a business or investment, resulting in a loss of control or less investment income. But with funds from an insurance payout, you might not be forced to sell prematurely should you need cash on hand.
Keep Assets Intact
With liquid assets, your loved ones have options. For example, some family members might be more interested than others in keeping a family home with sentimental value. Those who want cash can get paid from insurance proceeds, while those who value the home can take over the property (potentially debt-free).
Transfer a Business
Life insurance can provide much-needed funding to facilitate a business transition. For example, if you’re a partner in a business, would your surviving family members have the skills or desire to take over your interest in the business? If not, you and your partners can arrange for an insurance policy to buy out your share. As a result, your loved ones receive value from your lifetime of work, and the partners can get the funds they need to buy out your interest.
Provide for Special Needs
Life insurance can generate assets for special needs trusts. In some cases, the strategy helps families avoid tax consequences and preserve valuable benefits for those with disabilities or special needs.
Philanthropy
If you’re charitably minded, a death benefit from an insurance policy can provide a cash injection for your favorite cause. While naming a charity as a beneficiary is a simple way to give funds, insurance can facilitate more advanced strategies as well.
The Bottom Line
You can control what happens to your assets after you die, and with life insurance, you can substantially increase the assets you pass on. Those funds are often invaluable for everything from paying the bills to advanced wealth management strategies. To design a plan that fits your needs, speak with an estate planning attorney and an insurance agent licensed in your state. You might need to use specific legal documents, and you’ll likely learn about strategies that can help you accomplish your goals.
