Life Insurance’s Role in Estate Planning

May 28, 2023


With estate planning, the most common objectives are to preserve, create, or maximize the value of the estate that is left to your beneficiaries. That being said, there are some expenses that may occur upon death, such as probate fees, income taxes, and funeral expenses, which have the potential to chip away at the value of your estate.

Here’s where life insurance comes into play. Life insurance can play a critical role in estate planning, generally in two different aspects: the proceeds of a life insurance death benefit may be used to create or add to an estate for your beneficiaries or family, or the proceeds may be used to pay for expenses/liabilities that could arise upon death. The proceeds from life insurance can be used to help pay for debts, legal fees, funeral expenses, tax liabilities, and even probate fees, thus preserving the value of your estate for your beneficiaries’ sakes.

First, let’s take a look at what estate planning actually is.

What is estate planning?

Estate planning is not unlike life insurance in that it is something prepared when alive to prepare your beneficiaries’ financial futures in the event of your incapacitation or death. With estate planning, there are a series of tasks you must accomplish so as to determine how your individual assets will be managed, preserved, and distributed upon your death.

In estate planning, you may make a will, make charitable donations to reduce estate taxes and/or set up trusts, name beneficiaries and an executor, and set up your funeral arrangements. Estate planning does not solely apply to the “incredibly wealthy” – anyone can use estate planning and strategies to ensure that an estate is distributed adequately and that the custody of minor children (if any) is handled appropriately following your death.

As mentioned previously, life insurance can help estate planning in two ways. Let’s dig into that a little bit more in the sections below.

The creation of an estate

The death benefit that life insurance policies pay out is paid tax-free to your beneficiaries, which means that life insurance can ultimately be an efficient way to create an estate for your named beneficiaries.

One way you can do this is through tax-free accumulation. You may accumulate funds inside of an “exempt” life insurance policy (which doesn’t work with a term policy, FYI – be sure to ask an advisor which type of life insurance policy is best for this step.) You can invest funds into your policy to grow it on a tax-deferred basis until your death. Your beneficiaries will then be eligible to receive a larger payout.

Another way  you can do this is to use your life insurance policy to enable a reasonable distribution of your estate between your named beneficiaries. As an example, if you had a seasonal home which was purchased several year(s) prior, it may have increased in value over time. Upon your death, you have decided to dispose of the home at its market value, which can attract a capital gains tax bill. The tax liability might be paid out by your life insurance payout. If you choose to give the home to one beneficiary, the payout could be used to provide an inheritance comparable in value to your other beneficiaries, such that the estate would be equalized between all of your beneficiaries.

Life insurance payout can also be used as part of a charitable giving plan. By donating proceeds via your will, or naming a charity as your “beneficiary,” the proceeds are considered to be made by your estate.

The preservation or maximization of an estate

Because life insurance can help pay for debts, final expenses, taxes, fees, etc. – essentially whatever you want to use it for – you can use it to ensure an estate’s assets will not have to be sold to cover any remaining expenses that arise upon your death. An estate may be able to cover the following expenses to ensure the preservation or maximization of an estate:

  • Legal/probate, or other estate costs. Any costs that are associated with the administration of an estate may inevitably erode the value of an estate. If a will requires a probate certification, then there may be additional fees that life insurance can cover. Some estate costs that can be covered as well include burial/cremation, funeral expenses, including valuator or appraiser fees, executors’ fees, and legal/accounting fees.
  • Taxes/fees in other jurisdictions. If you own any assets that are located in other jurisdictions, then your estate may be subject to fees/taxes enforced by those jurisdictions.
  • Income taxes. Your estate may be deemed “responsible” for paying taxes on any income that was earned up to the date of your death. This includes, as well, the deemed disposition of all capital property, business and real estate holdings, investment portfolios, etc., which would not pass to a common law partner or surviving spouse. A life insurance policy tax-free death benefit may be used to help cover the income tax liability that occurs upon death, which can be extremely helpful if beneficiaries hope to retain any property that was inherited.

In conclusion, life insurance can help your estate planning proceedings in multiple ways – whether by facilitating the creation of an estate, preserving an estate, or maximizing an estate. It can help to manage certain costs that would otherwise chip away at an inheritance or help to ensure that any property that was inherited can be retained. Think of it, in this case, like a “shield” to help cover your loved ones with the funds they need to cover any remaining final expenses.

Give Excalibur a call to discuss your life insurance needs today or get a free quote. Ask us about how life insurance could be a critical aspect of your estate planning proceedings.