Hero Image

Using life insurance to transfer wealth

Share via:

Good estate planning answers three key questions: Where does your stuff go? Who is in charge? And what are the rules? Life insurance can be one of the most tax-efficient ways to answer these questions because it can limit tax exposure while protecting and facilitating generational wealth. Here’s a look at how you can develop a life insurance strategy that will help preserve your legacy for generations to come.

Benefits of using life insurance to transfer wealth

Most people think of life insurance primarily as a protection vehicle against lost income in the event of premature death. This is certainly how it is used frequently, but life insurance offers other meaningful benefits as well. Here are just a few of the reasons you may want to consider owning life insurance well beyond your income-earning years:

  • Quick access to liquidity at the precise time it is needed
  • Can offer a very attractive IRR% if structured properly
  • A known value that won’t change with market conditions
  • Death benefits are not income taxable for beneficiaries
  • If structured properly, can avoid estate and transfer taxes as well
  • Can offer lifetime protection as long as premiums are paid
  • Permanent life insurance can include cash-value that grows tax-deferred and offer tax-efficient access during life
  • Better portfolio diversification because the asset is not correlated to traditional market investments

How it works

Using life insurance to transfer wealth begins with identifying the key parties involved:

  • Who (or what) owns the policy?
    • This can be an individual, a company, or a trust depending on the circumstances and the objectives.
  • Who (or what) pays for the policy?
    • This can also be an individual, company, or trust. It is also common to use bank financing to pay the premiums when the circumstances are appropriate.
  • Who (or what) is the beneficiary of the policy?
    • Depending on who will need the liquidity, the beneficiaries can be designated and changed over time, if needed.

As you begin estate planning, consider consulting a team of fiduciary advisors and insurance experts as they will be able to offer advice on the best solution for your unique situation. One common way of integrating life insurance into an estate plan can take the following progression:

Life insurance owned in an irrevocable trust outside of the taxable estate

  1. Set up an irrevocable trust that aligns with your estate planning goals
    • Answer the “Three Questions”:
      • Where does your stuff go?
        • There may be specific business goals or aspirations for your family or charitable efforts. You will also need to establish the beneficiaries of the trust.
      • Who is in charge?
        • This involves establishing a trustee or trustees.
        • A trustee’s job is to interpret the rules of the trust and follow them.
        • They will be able to use assets within the trust (cash, stocks, bonds, etc.) to pay the premiums on your life insurance policy and distribute assets to the beneficiaries according to the rules set forth in the trust.
      • What are the rules?
        • What terms and conditions of access would you like to include in the trust? There are an infinite number of possibilities that can be written into the language around what the rules are. It is important to give this due consideration and employ the help of a professional to evaluate how to accomplish your wishes.
        • The key is to make sure that your financial assets are aligned with the values and vision you want to pass down to future generations.
  2. Apply for life insurance owned inside the trust
    • The trust becomes the owner — and more importantly, the beneficiary — of the policy. When the benefit is paid, it is not subject to estate taxes because the policy is owned by the trust and exists outside of your personal estate.
    • The trust can also purchase assets from the estate or loan the estate money to help prevent unwanted actions (like a forced sale of assets) and allows your heirs to offset federal or state wealth transfer taxes.
  3. Fund the trust with assets, then the trust funds the policy (see section below)
    • Choose which assets you would like to place in trust through either a gifting strategy, sale strategy, or a combination of both.
      • This can include business interests, income-producing property, cash, or other assets.

Funding life insurance

There are several ways you can fund life insurance within an irrevocable trust. Some options to consider include:

  • Gifting – You can gift assets to an irrevocable trust to pay for life insurance premiums. These gifts may be subject to gift taxes, but there are ways to minimize the financial impact using an annual gift tax exclusion or a lifetime gift exemption. What’s important to consider here is the total ROI realized when you compare the value of the gift against the amount of benefit paid.
  • Personal loan – You lend the trust the funds to pay for insurance premiums. This allows you to move larger amounts without being subject to gift taxes. But the IRS does have strict guidelines for the rate at which these loans must be repaid. So, consider working with your financial advisors and attorneys to craft a lending agreement that provides the greatest benefit to beneficiaries.
  • Commercial loan – You partner with a bank to pay the premiums on your or the trust’s behalf. While this can significantly improve the potential economics, it is important to consider liquidity restrictions and interest rate risks associated with this strategy.

The three funding methods mentioned above are used most commonly because they can offer significant tax advantages. But there are other options. Consult with a team of financial advisors to determine the best course of action for your current financial situation.

Other types of trusts

An irrevocable trust is the most common vehicle for individuals looking to leverage life insurance for tax benefits. But there are other types of trusts that may be more suitable for your needs. Ask your financial advisor if any of the following may offer additional benefits:

  • Spousal Lifetime Access Trust (SLAT) – “Out of the estate, but not out of reach”
  • Grantor Retained Annuity Trust (GRAT) – Great for a retained income stream during life, and “freezing” the value of an appreciating asset for estate tax purposes
  • Intentionally Defective Grantor Trust (IDGT) – Allows the grantor to pay the income taxes as a form of tax-free gift to trust
  • Charitable remainder trust – Leaving the remaining assets to charity after death and retaining an income stream during life is attractive to some while getting a significant tax deduction today
  • Dynasty trust – A trust that cannot only avoid your estate taxes, but be excluded from the next generation’s estate for tax purposes as well
  • Incentive trust – A great way to promote specific behaviors in children and grandchildren
  • Special needs trust – If you have a child or grandchild with known special needs, this can be a useful tool to protect and preserve assets

Re-thinking the benefits of life insurance

High-net-worth individuals have a lot of options when it comes to estate planning. But the most important thing is making sure your legacy is protected, your family is supported, and your goals are accomplished. Life insurance provides a simple solution to achieving all of those objectives. By facilitating tax-advantaged wealth transfer, life insurance can be the solution you need to create an estate plan that ensures your legacy will continue for generations.

Have questions about life insurance or estate planning? Contact Granite Harbor today and our team of insurance experts and financial advisors can provide answers and help you develop the right strategy to accomplish your goals.

Schedule a Consultation