Creative uses of life insurance as a tax and wealth-planning tool

Opportunities for high-net-worth families to utilize life insurance are sometimes overlooked. But with the change in the interest rate environment, the cost of life insurance could be less than in the past, casting a new light on this option as a tax and wealth-planning tool.

Smart Business spoke with Doug McCreery, CEO and Managing Member of CM Wealth Advisors, about creative uses of life insurance.

What are some key uses of life insurance?

Accumulated liquid wealth that will survive death and taxes tends to mitigate traditional life insurance needs. This is particularly true if equity investment earnings provide a better return than eventual insurance proceeds. However, insurance may be a reasonable choice for younger families, even if they are part of a wealthy larger family group. Purchasing term or whole life policies may be a good alternative to replace the loss of earned income if a premature death takes away earnings that support a young family’s lifestyle. Insurance may help avoid the younger family needing to rely on family wealth held by elders for support.

Another common purpose of life insurance is to provide funds for the purchase of the ownership interest of a deceased business owner. This may be particularly important if the liquid assets available to the surviving owners are insufficient for this purpose.

What creative opportunities are overlooked?

An example of a more creative use of life insurance is enlarging a gift to a favored nonprofit. This may be structured so the nonprofit is the beneficiary of a trust that owns the insurance policy. Premium costs of the policy are paid to the trust for the institution’s benefit, so, subject to certain rules, the annual gift funding the policy is income tax deductible. If, for example, a couple funds a second-to-die policy for this purpose, ten annual payments of $50,000 might result in an eventual payout to the institution of as much as $2 million or more, depending on the couple’s age, health, and other considerations.

Life insurance can also be used in the context of estate planning. The expanded estate tax exemptions, now over $27 million per couple, are scheduled to collapse to $5 million at the end of 2025 (then indexed up for inflation), unless Congress intervenes. Keeping in mind that for married couples, the estate tax is assessed on the assets of the second-to-die, this is another instance where a second-to-die life insurance policy may be a wise consideration to offset the loss of family wealth because of the estate tax.

Also, while insurance premiums are generally not tax deductible, paying the premiums removes that cost from the estate taxable assets of the deceased. Said another way, if the estate tax rate of 40 percent applies, paying a life insurance premium receives a discount of the estate tax. To estimate the value of the savings, both length of life and investment rate of return need to be considered.

In the context of family wealth planning, policies benefiting skip generations (grandchildren and further on) may be an effective tool to project wealth into the future. A trust for the benefit of future generations can be established to own insurance on the grandparents’ lives. Potentially, annual gift exclusion payments may be directed to the trust to pay for the policy, so the policy benefits the skip generation without estate or gift tax cost. For more substantial policies with larger premiums, a variation of this approach is to make a gift to the trust using a portion of lifetime estate and generation-skipping exemptions. Again, depending on the age and health of the senior generation, substantial wealth can be created in the skip generation through these plans.

Who should people consult with about these opportunities?

Life insurance is one of a wide range of options and should be evaluated with objective advice from trusted advisers. Life insurance company agents, however, are in the business of selling life insurance. So, it’s important to seek advice from unbiased sources, such as a multi-family office that combines accounting, estate planning and legal considerations when giving advice. While not a one-size-fits-all solution, life insurance may have a valuable role in holistic family wealth planning and may deserve a second look if it has been minimized or avoided in the past.

Douglas McCreery

CEO and Managing Member


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