Life Insurance as Part of Your Estate Plan

Kristen R. Testaverde, Esq. 

Life insurance is an important part of estate planning, particularly for a younger client, as it may be his/her most valuable asset.  People often have questions about how life insurance works and different types of policies, on which I hope to shed some basic light here.

How it works:  An insurance policy is a contract between the insurer (the insurance company) and the owner.  The owner pays premiums to the insurance policy.  The owner is often the insured person.  In other words, if you have life insurance, it is likely on your own life.  An owner can take out a policy on another person’s life as well, however, so long as that person has an “insurable interest” in that person’s life (a strong reason for keeping the insured alive, like a close family member).  When the insured person dies, the insurer pays a beneficiary or multiple beneficiaries the proceeds.   People purchasing insurance policies should be particularly careful when naming a beneficiary.  Failure to name a beneficiary will make the policy payable to the estate of the deceased and end up placing the property through the probate process, often causing significant delays.  The owner can often pick from payment options, such as a lump sum or installments for the beneficiary. 

Types of Life Insurance: 

Term life insurance.  Term life insurance is the basic type of life insurance that lasts for a specified period of time.  If the insured person dies during that time period, the proceeds are paid to the beneficiary.  Term life insurance is economical for younger/healthier individuals as the premiums only cover the specified term.  These premiums however, increase over time.  Further, the policy builds up no cash value.  Thus at the end of the term, if the insured person survives, there is no return on the investment.  This type of policy is useful for young couples with children, or a mortgage, etc. to provide security for the other. 

Whole life insurance.  Whole life insurance provides insurance protection for the entire life of the insured person and is payable to the beneficiary on the insured’s death.  The premiums are more expensive than that of term life insurance and thus often overly expensive than necessary for younger people.  Whole life insurance also has a cash or surrender value which accumulates and can be borrowed against.  While the rate of borrowing may be favorable however, it should be noted that the person will be paying an interest rate on his/her own money.  The owner can also decide to stop paying premiums and cash out the policy at a lesser value.  

Universal life insurance.  Universal life insurance is very similar in function to whole life insurance, but with a more competitive rate of return, as if the owner had made other types of investments.  The policy may also offer more freedom to make adjustments regarding premiums or investments.

Endowment life insurance.  Endowment life insurance acts as whole or universal life, but the owner stops paying premiums at a certain predetermined age.   At that age, the cash value will equal the face value.  If the owner survives that age, he may receive a lump sum payout.  Premiums are often high on such policies, as the insured is often likely to outlive the predetermined age. 

Split dollar life insurance.   Split dollar life insurance is insurance with premiums paid for by both the insured and the insured’s employer.  When the insured dies,  the employer is paid back with part of the proceeds, usually a reimbursement for the payment of premiums.  The balance is paid to the beneficiaries. 

I hope this helps those looking into life insurance policies with a basic understanding of how they work and how policies differ.  Please post your questions/comments and thank you for reading!