Estate planning is one of the major elements of any financial plan. It is the process by which you organize for the transfer your assets to your loved ones during your lifetime and after your death. This helps you achieve the goal of protecting their needs when you are not around.
Various tools are available through which you can do estate planning. Wills and succession planning are the most notable and probably most written about. However, there is low awareness about life insurance. Perceived more as an instrument to generate wealth during lifetime, it is a tool which provides financial support to your family or loved ones after your death. There can be many circumstances which go against you. Life insurance gives a financial support in such situations. This is the primary objective of estate planning.
Types of life insurance
There are two types of insurance policies which are used in estate planning:
a) Term Insurance– These are pure protection policies where company pays out the death benefit to the nominee of the policy holder. There is no cash value accumulated and all premium payment is allocated towards cost of the protection cover. There are varieties of term insurance available including decreasing term insurance value and increasing death benefit.
b) Whole life Insurance: This is a term insurance accompanied with a savings accumulation benefit. The policy provides death benefit till the life insured is alive. The savings get accumulated in cash value as per the investment mandate. The premium payments in these policies are higher as compared to term insurance due to savings element. There are two variants of whole life insurance policies – traditional and unit linked, each having their unique features and benefits.
Benefits of life insurance in estate planning
- Protection to the family: Life insurance is bought for giving the family a financial support in case of any mishap. Generally, the surviving spouse and children are the beneficiaries. It is necessary that the needs of your family are assessed correctly and the right cover is bought. A term insurance bought on your life works efficiently in fulfilling this objective. However, there have been instances when the spouse or children of the deceased have been deprived of this benefit by relatives and other members. Married Women Property (MWP) act gives the right protection in resolving any kind of disputes. Any insurance policy registered under MWP in the name of husband for the benefit of wife, children or both, is deemed to be a trust and cannot be touched by any creditor. Also, the husband does not have any control on the proceeds and neither it form part of his estate. This make sure that benefit accrues to the spouse or children, whatever the circumstances.
- Retirement: Although pension plans have been in the forefront when it comes to retirement planning, very little is known about benefits of whole life insurance policies. Once savings get accumulated, you can withdraw cash or convert it into annuity which will provide income at retirement. Also, such policies if assigned on children’s names, can be utilized by them for meeting their financial goals as they will have enough time to grow their money.
- Disputes settlement: Many times, having a large number of members in the family leads to family feuds and the distribution of the estate goes to the Court for settlement. The family has to fight a long battle which results in a huge cost. The major sufferers in such cases are the spouse and children of the deceased. Also, if the deceased has run up huge debts then the obligation to pay is on the spouse and children. A life insurance policy can come in handy for providing funds for estate settlement costs or meeting debt obligations of the deceased.
- Business protection: Parents, whose adult son/daughter is going to take over the business, buy a life insurance policy in their names. This protects the parents, as an early death can disrupt the business. Even in cases where more than one owner is involved, like partnership firms, the early death of any one partner can seriously impact the business. The life insurance provides funds to the surviving partner to buy the partnership interest of the deceased partner from the heirs. This keeps the business intact as an ongoing enterprise.
- Estate building– Life insurance can also be used to create or enhance an estate. The proceeds from a life insurance policy provide money to heirs at the required time.
- Estate protection: Families which are involved in the farming business have a sizeable amount of land/farm and there can be members who are not dependent on the farming for their livelihood. However, every member has a share and with the death of a member the asset is split up into small units of uneconomical size so that there is an equal division among all children. To prevent such instances, the parents take life insurance policies in the names of non-farming members and they receive the proceeds. The savings can be at such a rate that it gives the same amount as the estate in child’s name thus keeping the farming business intact to the operating heirs.
Ownership of life insurance policy
Who owns a life insurance policy is of great consideration in estate planning. If it is on the deceased’s name, then policy proceeds are treated as part of owner’s estate after the death, regardless of who is the major beneficiary. If in between, the policy ownership is changed or the policy is transferred to some other name, the new owner can change the beneficiary or surrender the policy to take the cash value. Hence, while making such decisions the ownership issue should not be taken lightly and care should be taken especially when relationships become unstable or the owner’s credibility is doubtful. This is most appropriate when parents choose guardian’s for the life insurance policies for their children’s benefit.
Designating a beneficiary
The beneficiary in any life insurance policy is generally the spouse and the children. The husband makes the spouse the beneficiary in his policies and vice versa. If neither of them survives, the benefit goes directly to the children or to a trust created for the children’s upbringing. The proceeds might also go to an estate if there are no immediate surviving heirs of the deceased. Care has to be taken while selecting the beneficiary as the strategy sometimes can lead to taxation problems. The life insurance proceeds can also be included in your estate if you have been the owner of the policy. Thus taking the help of an estate planner is advisable to avoid any disputes later on.
Life insurance, as shown above, can have multiple benefits if utilized efficiently. There are many life insurance companies and so are the products. Choosing the best policy is a difficult decision as also the amount of life insurance to buy and which one to utilize depends on many factors like age, composition of family and the total estate, what is the risk involved and the family needs after your death. You should analyze these factors carefully before buying any life insurance for estate planning. Most importantly, review life insurance needs periodically as your family needs and estate composition will change during your lifetime.