Estate Planning and Insurance Policies: What You Need to Know to Protect Your Loved Ones

As part of their overall estate plans, many of our clients purchase life insurance policies.  These offer them the security in knowing that their loved ones will not have to worry about liquidity, paying outstanding bills, or estate taxes. The best type of insurance and the most efficient way to hold an insurance policy is dependent upon the needs of the insured and his or her family.

To illustrate, we have provided the following scenarios:

Scenario 1: Term Life Insurance

Michael is the CEO of a growing and successful private company. His wife does not work, but helps to manage the household and the schedules of their three children, all of whom attend private school. Michael and his family live in a home in Los Altos that has a mortgage of $2M. Although the family has about $1M of savings and investments, most of their net worth (estimated to be $10M) is tied up in Michael’s company’s stock, only some of which is currently vested.

Term life insurance is one of the least expensive forms of life insurance and also one of the easiest to purchase.  Term life insurance provides set coverage for a specific amount of time.  Typically, terms last 10, 20, or 30 years.  This type of insurance is typically purchased to ensure that  the beneficiaries are protected should a sudden death occur, and is likely the best type of insurance for Michael’s family.  Michael can purchase a $5M, 20 year term life insurance policy, held by himself and his wife.  If Michael dies during the term of the policy, his wife will receive the proceeds of the policy tax-free.  She can use the proceeds to pay off their mortgage, pay funeral expenses, and pay school tuition. While term insurance will yield no payouts beyond the term of the insurance, it does provide the family with peace of mind that their financial needs will be met in the case of an unexpected death.

Scenario 2: Whole Life Insurance

Ann is a retired venture capitalist with grown children and many grandchildren. Throughout her lifetime, Ann has created various family partnerships in which she invests and in which she has gifted/sold interests to her children and grandchildren. While Ann is no longer an active venture capitalist, she still invests heavily in various venture capital funds. Her total net worth is about $50M, but she currently only has about $10M in liquid assets.

Whole life insurance spans the lifetime of the insured and guarantees that the premiums that are being paid during the life of the insured will provide a benefit to the beneficiaries at the time of death.  In addition to lifelong insurance coverage, a portion of the premiums paid goes toward a cash value account that grows tax-deferred.  Over the years, the policy may accumulate cash value large enough to fund the premium payment or even to allow beneficiaries to borrow from the policy. It is not uncommon for permanent life insurance to be purchased to provide cash needed to pay estate taxes. This type of insurance is probably the best type of insurance for Ann’s situation. Ann can invest in a $20M whole life insurance policy that is held by an irrevocable life insurance trust (“ILIT”).  Each year she should gift funds to the trust to pay the insurance premiums.  When Ann passes, the trust will receive $20M tax-free.  The trust can use the funds to pay the taxes on Ann’s estate, which will keep the estate from having to liquidate its venture capital investments. If Ann’s trust owns the policy, life insurance proceeds are not includible in her estate. 

If you are interested in learning about how life insurance might fit into your estate plan, or if you would like additional information about Irrevocable Life Insurance Trusts, please contact our office to schedule an appointment with one of our partners. We are happy to assist you in determining which type of insurance is best for you and your family.