Protect What You’ve Built: Use Life Insurance in Your Planning

Life insurance can be a powerful tool to incorporate into your estate and broader financial plan, particularly if you are a business owner.  This is due, in large part, to the tax-free nature of income tax treatment of life insurance death benefits.

Life insurance serves as a tax-efficient tool that allows you to pass wealth to your loved ones while minimizing tax liabilities. By incorporating life insurance, you can ensure distributions to your heirs are equalized, making the process fair and equitable. Additionally, life insurance can help replace any wealth lost due to death taxes, allowing you to preserve the financial legacy you intend for your beneficiaries.

 In an estate plan, life insurance:

1. Benefits your loved ones in a tax-efficient way. Proceeds paid from life insurance due to the insured’s death are income-tax-free for federal income tax purposes.  Additionally, life insurance ownership can be structured so proceeds can pass to heirs free of death taxes¹.
2. Equalizes distributions to heirs. There are times when it may be challenging to distribute assets equally among heirs.  This can often be the case for the business owner who has a child involved in the family business, but not for the other children.  Life insurance can be a great way to equalize the distribution of the estate².
3. Replaces wealth lost due to death taxes.  The Federal government and some states impose a death tax on the assets one has at the time of their passing.  Utilization of life insurance, when ownership is appropriately structured, can be a great way to pay death taxes without affecting illiquid assets or assets that are depressed due to cyclical market conditions³.

As a business owner, life insurance also plays a critical role in estate planning. It provides you with efficient means to transfer ownership of your business to your heirs while addressing the illiquid nature of business assets.  Furthermore, life insurance can mitigate the risk associated with the premature passing of a key person within your company. This allows for a smoother transition of the business to surviving partners, ensuring continuity and stability in operations.

In business planning, life insurance:

1. Passes the business to heirs in a tax-efficient manner. In addition to providing liquidity for the business that may be needed at a crucial time (at the death of the owner), if properly structured, life insurance can supply money to pay possible death taxes while protecting the business and future growth for heirs⁴.
2. Serves as a safeguard against the risk of unexpected death.  If you or a key employee plays a crucial role in the success of your business, it’s important to consider what would happen if you were to pass unexpectedly. This situation can create significant emotional distress for both your family and colleagues. If you were the key driver of the business’s success, it may struggle to operate in the same capacity⁵. Life insurance can offer important protection in the event of such a loss.
3. Can play a crucial role in helping you transition your business to the surviving partners. There is more than one way to structure the buyout of a deceased partner’s ownership interest.  One option is a cross-purchase arrangement, where you and your partner each own a life insurance policy on the other to help fund a buyout of the deceased partner’s interest⁶.  Another option is a redemption agreement, in which the business itself owns the insurance policies for each partner. The proceeds can be used to redeem the interest of a deceased owner⁷. Both methods have their advantages, so it’s important for you to consider which option best fits your business’s needs.

Incorporating life insurance into your estate and business planning can provide significant financial security for your loved ones and ensure a smooth transition of ownership. Start evaluating your life insurance options today to safeguard your legacy and protect your business’s future. Reach out to a financial advisor to discuss how life insurance can be tailored to meet your unique needs and goals.

¹How to Use Life Insurance to Leave an Inheritance – NerdWallet

²Should You Add Life Insurance to Your Estate Plan? | Charles Schwab

^3,4The Role of Life Insurance in Estate Planning: Ensuring Financial Security

⁵Keyman Insurance – Forbes Advisor UK

^6,7Cross Purchase vs. Stock Redemption: What’s the Difference? | JRC Insurance Group™