BMO Family Office
By now you know that life insurance is a must in order to protect the people that you love. The more responsibilities you have, the greater your need for life insurance. How would your family get by if you were to die unexpectedly?
But while protection for your loved ones remains the most important reason to buy life insurance, the uses of life insurance don’t end there. It’s also an excellent tool for estate planning, business continuation and charitable giving.
Make sure you’re covered
Life insurance is first and foremost a risk mitigation strategy so that if the unthinkable happens your loved ones won’t have to suffer a financial hardship. Life insurance is surprisingly affordable, especially if you are young and in good health.
The first question you need to ask is “How much life insurance do I need?” The rule of thumb is to get at least 7-10 times your annual income. In other words, if you earn $75,000, you need a policy which has a death benefit of at least $750,000.
“But every situation is different,” notes Vanessa Wilson, Insurance and Annuity Product Manager at BMO Harris Financial Advisors.
Someone with high amounts of debt or a special needs child may need more life insurance because those expenses will continue to be high for your heirs even after you die.
Life insurance policies come in two varieties: term and permanent. Term life insurance “acts as a short-term financial safety net,” explains Wilson. For example, if you have small children and a mortgage, aim to get a life insurance policy whose term is at least as long as those financial obligations are in place. You’ll want enough insurance to maintain your family’s lifestyle, pay for your children’s college expenses and even help your surviving spouse with retirement savings. Term life insurance is an affordable way to obtain that protection.
Permanent life insurance, on the other hand, lasts your entire life, but it’s more expensive. Some people find that the expense of permanent life insurance can help them accomplish other financial goals and are willing to accept the higher cost.
What else can life insurance help you do?
#1 Business continuation
If you’re a business owner you know that your success depends on the people who run the business—including yourself. The untimely death of any of these individuals can have a devastating effect on your business. All businesses are well served by having a buy-sell agreement, which can allow for the orderly transfer of ownership. Life insurance is a way to fund these agreements.
“When life insurance is used to fund a buy-sell plan it can provide immediate liquidity necessary to ‘buy-out’ the interest in the business upon death, ensuring that the heirs receive a cash inheritance while allowing the remaining owners to continue to run and maintain the business,” explains Wilson.
When you use permanent life insurance, you have even more flexibility. Along with the death benefit, a portion of your premium is used to fund a cash value account, which accrues inside the policy.
“[The cash value] can be accessed on a tax-preferred basis during your lifetime, perhaps to help fund a buyout of an owner,” Wilson says.
#2 Estate planning
Smart estate planning helps to protect an estate’s value against erosion and is “a cost-effective way to fund for capital needs at death,” Wilson says. Life insurance can be used as a source of funds for several estate planning needs.
For example, let’s say you’re a business owner with two children, only one of whom is interested in taking over the business. You might worry about the imbalance of leaving this valuable asset to just one of your children, without providing an asset of equal value to your other child. Life insurance can be used to equalize the estate, providing the child who isn’t involved in the business with his or her fair share.
Another use for life insurance is as a source of funds for estate taxes if your estate is larger than $11.2 million (remember, state estate tax exclusion amounts are typically much lower, even as little as $1 million). Your heirs can use proceeds from a life insurance policy to pay estate taxes.
“With life insurance, funds are available when needed, preserving the estate assets,” says Wilson.
What’s more, with a properly structured irrevocable trust, the life insurance death benefit proceeds can be distributed to heirs free of income, gift or estate taxes, Wilson notes.
Gifts to the charities and causes you love don’t have to end at your death. You can use life insurance to keep your philanthropic intent going into the future. Life insurance is a boon to charities because they can avoid probate and receive their funds quicker. There are several ways to structure this.
First, you can use the proceeds of a life insurance policy for a bequest if you designate your wishes in your will.
Alternately, you can name the charity as a beneficiary under a policy you own. By donating a life insurance policy you can enjoy a charitable income tax deduction for the initial donation as well as for any premiums paid in the future.
Or, you can irrevocably transfer a life insurance policy to a charity. If you pay the premiums, those are considered charitable donations and eligible for a charitable tax credit. Bear in mind that only premiums paid after the transfer of a policy qualify as charitable donations. Those paid before do not.
Gifting a life insurance policy has the added benefit of reducing your taxable estate and possibly lowering your estate taxes. Always seek your advice from a tax professional when gifting a life insurance policy.
No one likes to think about life insurance. Even fewer people like to plan for it. But life insurance is one of those crucial elements of financial planning that can’t be ignored if you want to protect your family against hardship. Fortunately, it can also help you with several other financial goals. When structured properly, life insurance can be an effective way to plan for business needs, estate planning and even realize your charitable intent.
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