Written by: Raymond Caucco | Penn Mutual
The traditional thinking about life insurance is that you only need life insurance when you have an income to protect, when you have a mortgage, or when you have kids to support. Once you hit 65 and retire, says the myth, you don’t need life insurance. That is not true. There are many good reasons for having life insurance after 65, though it is true that it isn’t right for everyone.
If you have an existing permanent life insurance policy, for example, you may be able to tap into accumulated cash value as a form of retirement income. You can incorporate the funds inside your permanent life insurance policy to complement other forms of retirement income such as Social Security, 401(k) plans, and IRAs.
There also comes a point where people become concerned about outliving their retirement savings. Drawing on the cash value of a permanent life insurance policy enables people to use other resources to guarantee lifetime income, such as a longevity annuity or a guaranteed living benefit.
What if you don’t have an existing life insurance policy when you retire? Maybe you bought into the idea that you should only buy term life insurance and invest the difference. Maybe you did invest it, or maybe you spent it. No matter, there are reasons that permanent life insurance might be a good idea for you after retirement. One in particular is to transfer wealth from one generation to the next.
3 Ways to Use Life Insurance for Wealth Transfer
Life insurance can be an effective vehicle for transferring wealth to your heirs while avoiding inheritance taxes. While the federal exemption for estate taxes have been raised to $5.43 million for 2015, there are still state inheritance taxes to consider. There are several states in the U.S. where you wouldn’t want to be caught dead, from an estate planning perspective.
Of course, such policies have to be set up correctly. Life insurance payouts are generally free of income tax, but they are still subject to inheritance taxes if they are owned by the insured. That is, if you own a policy on yourself, then it is considered part of your estate.
Here are three examples of how permanent life insurance can be used for wealth transfer:
- Set up an irrevocable life insurance trust. You would then gift premiums to the trust — as long as the gifts are under the annual gift tax exemption, you wouldn’t have to worry about paying gift tax. The beneficiary of the policy would be the trust rather than your estate, so the policy wouldn’t be included in your estate for estate tax purposes. The proceeds of the trust would then be distributed to your children or grandchildren, however you set it up. The downside of this approach is that, because the owner of the policy is an irrevocable trust, you have no access to that policy. You give up any access to it in exchange for the tax benefits.
- Use a survivorship policy. If you might need access to the cash value of the policy, you can use a survivorship policy, one that covers multiple people and doesn’t pay out until the last person passes away. Initially, the policy would be owned by one of the insured, but when the first insured passes, the policy would then move into a trust. The trust becomes the beneficiary, avoiding estate tax because the survivorship policy pays the death benefit on the last death, not the first death.
- Insure the children for the benefit of the grandchildren. This can be a very cost-effective way for people in their 60s or 70s to use life insurance for wealth transfer in a “skip generation” strategy. Generation 1 owns the policy, so they can have access to the cash if they want, but then when they die, the policy goes into a trust for the benefit of generation 3.
These are complex matters, so you will want to discuss these items with your financial and legal advisors to determine what post-retirement life insurance strategies make sense for you.
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