The subject of life insurance often arises in the context of estate planning as “a way to keep the cottage in the family.” While that’s one absolutely valid use for life insurance in an estate plan, there are a number of other important life insurance strategies that should also be considered when putting together an estate plan, including paying final expenses, providing survivor income, paying off debts, preserving estate value, ensuring estate equalization, and making bequests.
Final expenses
These are costs that arise on death, and include the cost of cremation and/or burial, preparation of the final income tax return, and any taxes owing, as well as legal and accounting advice. These expenses can add up into the tens of thousands of dollars, depending on the complexity of the estate and the care that has been taken in the estate plan.
Survivor income
If the income for a surviving spouse will be greatly reduced by death of the first spouse, a life insurance strategy may be a solution. This could occur if pension income is reduced or investment management skills are lost on the death of a spouse. Another factor that enters into this need is age difference. In blended families, the wife may be many years younger than her husband and there may even be education costs for children that are yet to be paid. If survivor income is an objective when applying for a joint policy, it must be structured as “first to die” to ensure the survivor will receive the money she needs during her lifetime.
Debt payment
This is another concern, particularly in regards to mortgages and reverse mortgages. If an individual wishes to leave the value of a principal residence unencumbered by debt to an heir, then the death benefit of a policy, paid on the death of the second spouse, may need to accommodate repayment of real estate expenses. Other items of debt that could significantly reduce estate residue would be credit card debt and investment loans taken for the purpose of leverage.
Preserving estate value
Life insurance can play a vital role in the protection of estate value through the insured annuity strategy. An insured annuity seems too good to be true, but fantastically enough, it is real, legal, and just waiting for applicants to sign up.
The strategy consists of a life insurance policy and a life annuity. First, an application is made to the life insurer for a permanent policy – a term-to-100 policy is typically used in this type of strategy. Then, an application is made for a life annuity without a guarantee period. This ensures the maximum is received as the annuity payment.
The life insured is the same person as the annuitant. Payments to the annuitant from the annuity are more than sufficient to pay premiums on the policy. When the life insured dies, the annuity stops but the death benefit of the policy is paid to the beneficiary. In this way, the life insured/annuitant has enjoyed their capital during their lifetime while the death benefit paid is the same (or more than) if the annuity hadn’t been bought.
The challenge with the insured annuity strategy is to find the right sum to capitalize the annuity, which yields enough for premium payments and the correct amount of death benefit. The insured annuity is typically positioned as a balance between the capital used to buy the annuity and the ultimate death benefit. However, the two sums do not have to be balanced: one could acquire a life policy with a more modest death benefit and have more annuity income to spend.
Equalizing inheritances
Life insurance is a very useful way to pay beneficiaries and equalize inheritances, particularly when one inheritor or group of inheritors stands to gain the value of a particular asset – say, a cottage or a family business -- and others do not. To calculate the correct amount of insurance for such needs, it is wise to bring an accountant or other tax specialist into the conversation. An inadequate sum at the end of the day is not going yield the rosy situation envisioned when the plan was created.
Bequests
Life insurance delivers a double-whammy benefit: There’s no tax on the death benefit paid and probate is bypassed. That enhances the value of the life insurance benefit. Other positive aspects include the speed with which the benefit is paid, compared with the often snail’s pace involved in estate settlement when assets are liquidated.
To develop your estate plan and ensure you are taking advantage of all that life insurance offers, consult with your independent financial advisor. For more information on estate planning, the CLIFE course Estate Planning for Retirees is available now. Please contact me at [email protected] for a reduced price on the course that is provided to the general public.
Courtesy Fundata Canada Inc. © 2015.Susan Yates is president of the Centre for Life Insurance and Financial Education (CLIFE).This article is not intended as personalized advice.
