Life Insurance in Estate Planning
Life insurance is often looked at in terms of saving your loved ones from financial hardship in the event of your passing. But there is more to life insurance than simply paying out your mortgage.
It is true that the majority of life insurance holders take out cover to the big ticket items. Generally this is to extinguish personal and business debts, cover funeral expenses and in some cases to provide ongoing income via investment of a lump sum amount.
A less common strategy for using life insurance is for estate planning. Before we get into the details, we should start by covering exactly what estate planning entails.
Estate planning is the process of ensuring that, upon your death, your assets are distributed to the right people at the right time, and with the most favourable tax outcomes for all involved.
Including life insurance as part of your estate planning, and included in your will, is about more than just bolstering the inheritances of your loves ones, but of course this is one option.
Many Australian parents and grandparents would love to be able to give their loved ones a great head start in life by leaving them a healthy inheritance. For some people this won’t be a problem, but for many people they’d love to be able to give more.
A life insurance policy can be included in your estate planning process, and basically it will provide additional funds that can be distributed to the beneficiaries – your loves ones.
The proceeds of a life insurance policy paid out upon your death with generally be tax free for most of your beneficiaries, but it is important to check which of your beneficiaries will and won’t be taxed, and plan the distribution of your life insurance proceeds accordingly.
The strategy of simply bolstering your estate using life insurance is a fairly straightforward one, but there are more complex strategies where life insurance can be used effectively.
There are many issues that can come up in the time after your death, and unfortunately this period can tear apart even the closest families, as unfortunately the distribution of money can really bring out the worst in people.
So how can life insurance help in this situation? It all revolves around the subject of estate equalisation.
A common issue with the distribution of estates can revolve around property. Often the family home will be your estate’s largest asset, and if you have multiple loved ones included in your estate, generally you will have to split the home between these people.
The problem with splitting the family home between your loved ones is that they cannot all live in the home together, unless the home is very large! Instead, the only option for many families is to sell the home and then distribute the proceeds amongst the family members.
But what if one of the family members don’t want to sell the home? Maybe they could buy the shares of the other family members, but that’s not always possible. There are also other occasions where the family home, or any other significant asset, may not want to be sold.
Under normal circumstances this can result in major disagreements between your loved ones, which is the last thing you want when they should have this time to grieve together instead of arguing with each other.
Thankfully there is an easy solution to this problem, and it involves the inclusion of life insurance in your estate plan.
Let’s take the example of the Smith family. They have a family home worth $800,000 as well as cash and shares totalling $600,000. They also have four adult children which the estate is to be equally distributed amongst.
If each of the children were happy to tell the family home, the distribution of the estate would be very straightforward, however one of the adult children still lives in the family home with his wife, and would like to stay there.
The other three children are happy for him to remain in the home, but they want their share of the home’s value in cash, as they were entitled to in the will. His share of the home is worth $200,000, but he does not have access to the remaining $600,000 that he requires to pay out his siblings.
Under normal circumstances they would have no choice but to sell the home, which would leave one child very unhappy. The other children would get their money, but they still wouldn’t be happy to see their sibling miss out what they wanted.
Unfortunately, these types of situations can very quickly deteriorate and can create major rifts between otherwise close-knit families.
Thankfully the parents had a life insurance policy valued at $1,800,000. This mean that child one received the $800,000 family home, and the remaining three children each received $200,000 worth of cash and shares, as well as $600,000 each from the life insurance policy.
The overall outcome, thanks to the life insurance policy, was that each child received their $800,000 share of the estate and that child one received the family home that they so dearly wanted.
As you can see, life insurance had a major positive impact in this case. The parents did not require life insurance to repay any debt since they were debt-free, and they did not require life insurance for living expenses or any other reason since they had around $600,000 in cash and shares which would have comfortable seem them through the rest of their lives.
The Smith family is just one example of many cases where life insurance can be used in a positive way as part of your estate planning. Of course you could be paying premiums on the life insurance for a long period of time, depending on how long you life for, but those premiums will provide a healthy return when the time comes to distribute your estate.
Please remember that there can be tax consequences when distributing life insurance policy proceeds after your death, so it is important to take these factors into account when deciding on how to structure your life insurance.
