Estate planning is an important part of financial planning, and one of the key components to estate planning is having enough life insurance to cover any debts and expenses that may arise after you are gone. The question “how much life insurance do I need for Estate Planning” can be complex to answer but it doesn’t have to be. In this article we will help you understand the various factors involved in calculating your life insurance needs so you can make an informed decision and ensure you have enough coverage.
What do we pass on? Rick, age 69, the owner of a successful public relations firm, was concerned about passing on the result of a lifetime of hard work to the generations that were succeeding him. Now that his kids were having kids of their own, it was becoming even more important to him that they be able to enjoy the fruits of his labor. As he approached his 70th birthday, Rick’s financial concerns revolved around preserving his wealth and minimizing his estate tax exposure in order to leave as much money as possible to his heirs.
At an annual meeting with his financial planner, it occurred to him that maxing out his retirement accounts each year wasn’t doing enough. It was a conflicting strategy: His high tax bracket was reducing the value of many of his other investing strategies, leaving him unsure about where to put his cash. He wanted to make sure that he was protecting what mattered most to him: his kids and grandkids. He didn’t want to see a lifetime of hard work divided up outside his family or eroded by exorbitant income taxes. What Rick needed to do was take a deeper look into life insurance.
For Rick and many other people, life insurance is about more than just getting money to your spouse or kids in the event of an untimely death. Having the right life insurance that is properly structured can be an important wealth building and tax saving strategy to help preserve your legacy for your family after your death. People who see life insurance as just a safety net for others in the case of personal tragedy often miss out on the very real tax benefits that come with investing in the right policy. Rethinking a life insurance strategy can help your loved ones keep what is rightfully theirs by providing several benefits.
- Income replacement: This is the most traditional use of life insurance. If you haven’t put together a proper nest egg and were to die unexpectedly, life insurance can replace your income and provide money to pay for large expenses such as mortgages, college educations, and retirement.
- Estate tax liquidity: If you have saved enough money to make your family financially independent, or perhaps you recently came into more money by inheriting it from an older generation, life insurance can be used to pay the estate taxes that may eventually be due when you and your spouse die. Not only can life insurance create cash to pay for estate taxes, but it can also create the liquidity that is often necessary when family wealth is tied up in illiquid assets such as real estate or a business.
- Leveraging your estate: Life insurance can also be used to leverage the size of your estate. Rather than focusing solely on any estate taxes that may be due upon your death, life insurance can dramatically increase the amount of money you leave to your heirs by creating a tax-free rate of return that is often far in excess of traditional investments. This is especially true for people with large IRAs, annuities, and 401(k)s. Life policies that leverage these vehicles are often purchased inside of trusts, the details of which can be complex, so we encourage you to speak with us about exactly how to leverage the size of your estate using life insurance.
How much life insurance do i need for estate planning?
When it comes to income replacement, there are several ways to come up with a number. One method would be to estimate your future expenses. Say your family has $200,000 in annual expenses. If you’re 50 years old and want to cover 15 years of future expenses, you may decide to buy a $3.5 million policy. How is that calculated?
$200,000 x 15 years = $3M + an extra $500K
…because, as we all know, expenses tend to go up over time, not down.
A second method would be to purchase $4 million of insurance so that, at a 5% rate of return, your family would receive $200k of income off of that principle every year. In this manner, you’re not only creating income—you are also creating an estate to be passed on to future generations.
What you don’t want to do is buy too little and leave your family in a position where they may run out of money down the road. Again, there are a few different ways to approach income replacement, so thinking through your needs with a pro can help.
In the case of estate tax liquidity, you can try to estimate your estate tax exposure and buy a policy that will cover your anticipated tax bill. For example, if you had $10 million in assets at the time of your death but could only pass along $5 million tax-free, you would need a $2 million policy to cover the tax due on that additional $5 million of assets, which would be taxed at a rate of 40%. While that calculation may seem reasonably simple, there are some moving parts involved, such as constantly changing estate tax rules and the fluctuating value of your estate, which may include stocks, bonds, real estate, and other asset classes.
In the case of leveraging your estate, you may actually “back into” the size of your policy based on your available income. What does that mean? If you were 60 years old and could comfortably afford to dedicate $60,000 to your policy each year for the rest of your life, that $60,000 may ultimately buy you a $4 million policy based on your health class, the insurer you chose, and a few other factors. That $4 million would pass tax-free to your heirs, creating a solid legacy while only costing you $1-2 million in premium payments (and perhaps even less) over your lifespan.
A Knowledgeable Advisor Can Help
With so many potential variables, it’s important to develop a policy that’s tailored to your needs. Working with an experienced life insurance advisor who listens to you and can help put together the perfect policy is incredibly important. At Howard Kaye, we have that experience and wealth creation expertise you need. Contact us today and get started planning your legacy.
