• Financial Planning
  • The Right Type of Life Insurance for Your Estate Planning Needs

    by Peter Katt

    The Right Type Of Life Insurance For Your Estate Planning Needs Splash image

    Life insurance has been associated with estate planning for decades.

    It is believed that the estate tax has settled down to an individual credit equivalent of $5.34 million per individual in 2014. (The amount will adjust each year for inflation.) The estate and gift tax laws allow for “portability.” Portability allows a surviving spouse to preserve a deceased spouse’s unused estate tax credit by filing a federal estate tax return. This expands the amount that can pass free of estate taxes per couple to $10.68 million.

    Life insurance works for estate taxes because they are due when death occurs, the same trigger that that pays life insurance death benefits.

    But one life insurance size doesn’t fit all estate planning situations. Let’s go over the common situations.

    Pure Estate Tax Liquidity

    Paula, now 64, came to me six years ago. She is single with a son. She owns a fraction of a large apartment complex. It was decided that approximately $5 million was a good life insurance amount to cover her estate tax. She also decided to purchase a current assumption universal life policy to be protected against inflation and to have a decent cash values.

    Each year, we review her policy and change premiums to keep up with changing interest rates and in case her health changes (it hasn’t). She has her estate protected for her son. She could have opted for guaranteed universal life with guaranteed premiums, but knew she wouldn’t be protected against inflation. Plus, the policy would have low-to-zero cash values in case she ended up selling her real estate interest.

    Relatively Large Liquid Estate

    Dan and Rita have a large estate with mostly marketable assets. They don’t have a estate liquidity issue, but they may want to consider life insurance as a wealth transfer asset.

    Ideally they could use a participating whole life policy with increasing death benefits. The premiums could be set based on the annual gift tax exclusions, and they could even throw some of their gift tax credits into the policy. Life insurance benefits are income tax free, so they provide excellent income tax planning, and when held within an irrevocable trust they aren’t included in the estate. Under current financial conditions, the premiums to death benefit yields at life expectancy are in the 4.5% range.

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    Dan and Rita don’t need life insurance, but it is usually a worthwhile tax-advantaged asset to use.

    Significantly Large Liquid Estate

    Bob and Lois have the same issues as Dan and Rita, but a much larger estate, so they should certainly be moving their estate and gift tax equivalent amounts ($5.25 million) out of their estates, either to children directly or to an irrevocable trust.

    If a trust is used, life insurance is a good choice as an investment due to the tax advantages. Participating whole life with increasing death benefits is the way to go.

    For some reason clients and many advisers believe it is a good idea to save the gift tax credits. NO! Use them as soon as feasible because it is the growth outside the estate that counts. That is, if $5 million is gifted (purchasing life insurance with premiums over a period of years, let’s say) with a value of $8 million at the time of death, it is the $3 million that is out of the estate. The original gift amount of $5 million is brought back into the estate for final accounting.

    Also, keep in mind that if the $5 million goes down in value, the $5 million is still the value of the gift—so be careful with what type of assets are gifted.

    Can Term Insurance Be Used?

    Yes, if the need is for a specific period. As an example, let’s say our first client, Paula, has a buyout on her real estate investment in 10 years. Using term insurance works just fine for this situation. It provides estate tax liquidity in the event she passes within 10 years and it is fully liquid when the property is sold and the term policy is terminated.

    Second Marriage With Older Children From First Marriage

    This is a people-planning need. It might be good to have a separate life insurance policy for the older children so they don’t have to wait around until the second wife passes.

    Guaranteed Universal Life

    This has been very popular with agents and buyers for some time. It guarantees the premiums and death benefits usually to age 120. Usually there is low-to-zero cash value.

    The potential problems are if cash values might be needed or if there is a heavy bout of inflation, since guaranteed pricing is set. Current assumption universal life policies are protected from inflation because their crediting rates would likely go up.

    Periodic Reviews for Policies Is a Must

    All policies should be looked at every few years to test the continued creditworthiness of the company, to make sure the policy is properly funded and to reassess the insureds’ health.

    A particularly disturbing issue has been coming up in my practice: Many policies sold in the 1980s and 1990s mature at age 100 and agents haven’t explained this problem well. If an insured lives to 100, the policy pays out the cash value. However, some companies are taking it on their own to continue the policy until the insured passes and pay the cash value as a death benefit. If the insured is in good health with a reasonable chance of making it to 100, either the policy’s premiums need to be changed so the policy’s cash value will equal the death benefit at 100 or a new policy should be looked at.

    On the other end of the spectrum are insureds in poor health who will certainly not come close to living to age 100. They can probably stop paying any further premiums.

    But regardless of the specific situations, policies need an independent and professional review every few years.

    Premium Financing

    Do not be talked into premium financing (borrowing money to cover the cost of the policy). When insureds live to their life expectancy, financing of premiums and interest will almost always fall apart with an unhappy and expensive termination of the policy. If you can’t afford the premiums, buy less life insurance. While split dollar (a payment strategy where some or most of the policy premiums are paid by a third party that retains a collateral interest in the policy) has become mostly obsolete, it should not be used to finance premiums.


    Life insurance can be a valuable estate planning asset. Use the right type and use it wisely.

    Peter Katt CFP, LIC, was sole proprietor of Katt & Co., a fee-only life insurance advising firm located in Kalamazoo, Michigan.


    sasi madisetty from texas posted over 2 years ago:

    I got a universal life insurance in 1980 at age 33. A crook advised my husband to cancel my policy and sold a new policy with premium payments through loan.Now I am 66 yrs old, had to cancel that policy and lost lot of money and had to pay taxes on unrealized gains. I have a professional degree and a son. I just bought a term life policy now.I can not even share this story with my son to teach him through my mistake.

    John Kazlauskas from VA posted over 2 years ago:

    I bought a Universal Life insurance policy with flexible premiums in 1986. The aim was to have funds available for college tuition for my two kids. This was prior to 401ks/529s/IRAs (with $2,000 max. per year). The policy had a death benefit of $100,000 with premiums applied to the benefit. I now have $72,000 in cash value, so the policy would pay my beneficiary $172,000 tax free. The cost of the policy has gone from about $150/year back then to $1,500 today with more raises coming in the future, which I don't like. My agent recommends I convert the policy and use the cash value to buy an immediate annuity. Is this the best option I have?

    Charles Rotblut from IL posted over 2 years ago:


    We cannot give personalized advice. You may want to consider getting a second opinion from a different adviser, however.


    Mark Schmidt from CA posted over 2 years ago:

    down to an individual credit equivalent of $5.34 million per individual in 2014. (The amount will adjust each year for inflatio

    If this statement is true can I assume any one with an estate less than this amount WON'T have to pay an estate tax and if so you should include this in your article .

    Thank you
    Mark S

    DCG from OR posted over 2 years ago:

    True for the federal estate tax, which is what most planners talk about. What seldom seems to be addressed is that most state level inheritance tax triggers are considerably lower; eg OR at $1,000,000.

    Mary from WI posted over 2 years ago:

    Please explain the role of cash value in a policy.
    * If I have a policy with a death benefit of 100,000 and a cash value of 17,000, what amount is paid out at my death? Do I 'lose' the 17,000?
    *If I borrow the 17,000, then die, what amount is paid out, and must the borrowed 17,000 be repaid?
    *I've read that I can ask my agent to add the 17,000 to the death value so I would have a death value of 117,000 and no cash value. Is it accurate that that can be done?

    Charles Rotblut from IL posted over 2 years ago:

    Hi Mary,

    Here is the response from Peter Katt.

    * If I have a policy with a death benefit of 100,000 and a cash value of 17,000, what amount is paid out at my death? Do I 'lose' the 17,000?

    If the DB is level at $100k - DB is $100k - if it is $100k plus CV - amount paid is $117k - this is an option on ULs

    *If I borrow the 17,000, then die, what amount is paid out, and must the borrowed 17,000 be repaid?

    You can borrow less than $17k, if you borrow all CV, the policy will terminate

    *I've read that I can ask my agent to add the 17,000 to the death value so I would have a death value of 117,000 and no cash value. Is it accurate that that can be done?

    Yes and no - if health is good you may be able to change a level $100k to $100k plus CV - if this is done the CV will remain at $17k, but the overall cost of policy will increase because there are more DBs

    -Charles Rotblut

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