Oran Hall The importance of life insurance in estate planning
Estate planning is the ongoing process of acquiring assets and planning how to pass them on to individuals, causes, and organisations in the most timely, effective, and cost-effective way in life or after death.
Almost everybody has an estate for almost everybody owns something. Generally, people want to pass the ownership of their assets to the people they care about and to organisations and causes that mean much to them.
In many ways, how the ownership of assets is registered has some bearing on the ease, timeliness, and cost of passing them to beneficiaries.
There are several estate-planning tools. Living trusts and joint ownership facilitate beneficiaries deriving benefits while the benefactor is still alive. On the other hand, wills, testamentary trusts, and life insurance policies provide for beneficiaries to derive the benefits after the death of the benefactor.
Life insurance has a unique place among these tools. It is unlike joint ownership of financial and physical assets, which can slip out of the hands of the benefactor by fraudulent means. It is unlike trusts, which require financial or physical assets to be placed into them, and which may require time to build up. Neither is it like a will, which is primarily a tool to pass on the assets of the benefactor.
Life insurance creates an instant estate. Once the insurance policy comes into force, there is an estate, which can be quite large if the person paying the premiums can afford to pay them. But an insurance policy can lapse and be of no use to anyone if the required premiums are not paid in full and on time.
When there is a named beneficiary, the death benefit goes in good time to the beneficiary or beneficiaries if everything is in order.
When the beneficiary is stated as estate, meaning there is no named beneficiary, benefits take a longer time to be distributed because the will has to first go through the probate process. Therefore, it is important to move quickly and have in place all that is required to facilitate the quick settlement of the estate. Prompt settlement of the death claim, when there is a named beneficiary, makes it possible to have funds to settle testamentary and funeral expenses readily.
Life insurance as an estate planning tool also helps to provide funds to give extra financial support for loved ones. It reduces the chances of the lives of loved ones being disrupted. When there is a named beneficiary, it is also a very cost-effective way to provide for beneficiaries as there is no need to incur legal and other expenses.
For a business person, a buy/sell succession plan can be a useful estate planning tool. This plan defines how a business person and a partner will distribute interests in a jointly held business when one of them dies.
Life insurance can be used as a tool to fund this plan. Using life insurance to fund it ensures that the transition will be smooth by providing cash from the death benefit, which enables the surviving owner to buy out the deceased partner’s interest from his or her heirs if necessary. Life insurance policies are purchased on each owner and can be paid for by the business or by each owner.
This arrangement provides the heirs of the deceased owner with cash and allows the surviving owner to carry on the business if the heirs of the deceased have little interest in the business or do not have the required competencies to contribute meaningfully to it.
Life insurance must match the needs of the individual, so people planning to buy insurance should have a basic knowledge of the types of insurance and what they want to achieve. There is term insurance and there is permanent insurance.
Term policies have no cash value or investment element and have lower premiums than permanent insurance. They just provide a death benefit in exchange for premiums for some period of time, and there are some people who use them to provide the funds required to settle large estates.
There are some permanent policies that have fixed premiums and guaranteed increases in the cash surrender value. They have very low investment risk because the insurance company guarantees both the death benefit and the increase in the cash surrender value. Those are called traditional whole-life policies.
Another type of permanent policy allows both the insurance company and the policy owner to share in the investment risk. The insurance company guarantees to pay the death benefit but does not apply a guaranteed interest rate every year. Instead, the cash value is based on interest rates for a specified period, and interest rates vary over time. In some cases, the insurance company sets a floor for the rate of interest to be applied.
Another type of permanent policy allows for a portion of the premium to be invested in the securities markets, and the insurance company provides no guarantees of investment return, so it is the policy holder who bears the risk.
As important as life insurance is in estate planning, buyers should be guided by what is suitable for them and by what they can afford, bearing in mind that coverage can be increased as income increases.
Oran A. Hall, author of Understanding Investments and principal author of The Handbook of Personal Financial Planning, offers personal financial planning advice and counsel.finviser.jm@gmail.com