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Most people think of life insurance as
providing protection for their family in
case of the ultimate misfortune.
When the policy holder dies,
the beneficiary receives a payment
designed to replace the individual’s
income.
But life insurance has many
other uses, including:
Transferring wealth.
The death benefit from life insurance is
exempt from federal income taxes, but
not from estate taxes. However, estate
taxes can be avoided by transferring
ownership to a trust.
After the insured dies, the
death benefit can remain in the trust
and provide ongoing income to heirs. The
insured may use the trust as a way to
distribute income to children from a
previous marriage, or to control income
provided to children who may be
financially irresponsible.
A trustee is assigned to
control distribution of trust assets.
The life insurance trust is irrevocable.
You cannot change the beneficiary,
cancel the policy, borrow against it or
alter its terms.
Converting business
assets to income. A business with
multiple owners often fails after one of
the owners dies, because the remaining
owners typically have to buy out the
share owned by the deceased owner. Most
businesses do not generate enough cash
to make such a transaction.
To protect the business, and
the interests of all of the owners and
their heirs, a buy-sell agreement is
usually established. The agreement
ensures that, when a shareholder dies,
the surviving shareholders will purchase
the deceased shareholder's stock at a
fair-market price.
The agreement also creates a
vehicle for funding the purchase. Life
insurance policies that name the other
owners as beneficiaries are commonly
used, since it makes funds available
when they are needed.
Cash-value life insurance
can also be used to create an exit
strategy, since the owners may use the
cash value to buy out the shares of a
retiring owner.
Retirement income.
Life insurance has long been used as an
employee benefit, especially to retain
and reward key executives.
Executives often receive
split-dollar plans, which use cash-value
life insurance to generate income during
retirement. The company advances money
to the executive to pay premiums on a
cash-value life insurance policy. To pay
back the company, the executive makes
the company a beneficiary. The company
splits the death benefit and cash value
with the executive.
If the executive dies, the employer
receives a death benefit equal to the
amount it has paid into the policy. The
executive’s beneficiaries receive the
remaining funds.
If the executive uses the
policy to generate retirement income,
the company takes a share of the
policy’s surrender value when the
executive retires.
The policyholder can borrow
against the policy’s remaining cash
value, usually at a net interest charge
of 2 percent or less. The policyholder
avoids paying income taxes on the loan
as long as the policy remains in force.
Borrowing on the policy may be subject
to restrictions, and care must be taken
to ensure that loans do not cause the
policy to lapse.
Proposed regulations
complicate split-dollar plans and make
their tax treatment less favorable.
Borrowing. Cash-value
life insurance gives policyholders an
opportunity to borrow money for any
need. Loans may be made after the first
year of the policy and can be repaid at
any time during the life of the policy.
Loans are not subject to income tax
while the policy is in force. Loans may
reduce the policy’s cash value and death
benefit, and may be subject to interest
charges.
Life insurance can protect
your family from a financial
catastrophe. But, as these examples
demonstrate, it can serve many other
important purposes as well.
(William D. Smith can be reached at the
Mid Atlantic Agency in Raleigh.) |
