Many people are reconsidering their life insurance coverage. The new estate tax law and low interest rates change the equation for many people. But don’t make a quick decision. Make a careful review with your estate planner.
Most permanent life insurance was purchased to help pay estate taxes. The 2010 tax law moves many estates out of the taxable category. Despite the change, most of you should avoid irrevocably terminating the life insurance. Consider the broader picture, and you might decide to keep the insurance for at least a while.
The current tax law is in place only through the end of 2012. It could be extended, but it also could revert back to a less generous law including a $1 million exemption and 55% tax rate.
The life insurance likely has other benefits other than paying for estate taxes. For example:
? The insurance benefits provide liquidity for the estate to pay debts, allow equal inheritance shares without dividing ownership of assets, or prevent the sale assets.
? Life insurance might be required as part of a shareholder agreement or other contract. The insurance benefits also could help with business ownership succession by providing cash that allows purchase of the business from the estate.
? Life insurance can be a conservative, low return investment, so it could be a good addition to an estate that has primarily risky assets.
? The insurance can increase the legacy left for heirs or a charity. You could decide it’s worthwhile to keep the policy in place to provide the benefits to loved ones or a charity.
? The life insurance, especially if it’s owned through an irrevocable trust, has asset protection benefits. The benefits should be out of the reach of creditors of you and your heirs.
When you decide to keep the insurance, you still might want to make some changes. Most life insurance purchased for estate planning reasons is held in an irrevocable trust. While the trust is irrevocable, often there is flexibility. The trustee might be able to transfer the trust assets to a new trust with some different terms to reflect your new goals.
Some trusts were created with trust protectors, individuals appointed by the trust creator to monitor the trust and make selected changes to the terms. The trust protector could change the beneficiaries, move the trust to a state with more flexible laws, or change the distribution terms.
You might conclude that you no longer want the insurance policy. If so, don’t simply stop paying premiums. Consider other options. The trustee might be allowed to distribute the policy to the beneficiaries. They would then own the policy and its cash value and could choose to keep it in force, cash it in, or borrow against the cash value.
Don’t rush to make changes in your life insurance arrangements just because the estate tax law changed. There are other reasons besides paying estate taxes to own life insurance, and there often is some flexibility in current arrangements that could let you change them. Take some time to consider all the factors and discuss the options with your estate planner, life insurance agent, and other financial advisors before making an irrevocable decision to drop the insurance.
RW June 2011