Life insurance is a unique asset in that it serves numerous diverse functions in a tax-favored environment. Life insurance proceeds are received income tax free and, if properly owned by an Irrevocable Life Insurance Trust, life insurance proceeds can also be received free of estate tax.
Some of the frequent uses for life insurance include:
- Wealth Creation: Where age or other circumstances have prevented one from accumulating a desired level of wealth, life insurance can create instant wealth, for example, to build an estate, to replace a key employee, to buy out the interest of a business co-owner at death, or to pay off a mortgage.
- Income Replacement: Life insurance can provide wealth to replace income lost upon the premature death of the family “bread winner.”
- Wealth Replacement: Life insurance can provide the liquidity to pay estate or capital gain taxes after death. Life insurance can also be used to replace the value of gifts to charity or non-family members.
There are several types of life insurance, including term, permanent, and survivorship or second-to-die insurance. Term insurance, which includes annual renewable and fixed-level term (for example, 20-year Level Term) is temporary in that at the end of the term, the policy terminates and the insured must reapply at the then-going rates, based upon age, health, etc. Therefore, term insurance is often recommended for temporary needs.
Permanent insurance, of which there are several types including whole life, universal life, and variable universal life, are intended remain in-force until the insured’s death, and thus are often recommended for permanent needs.
Survivorship or second-to-die insurance pays out at the death of the survivor. Therefore, second-die insurance is often recommended in those circumstances where the liquidity need arises only at the second death; for example, the need for liquidity to pay estate taxes.