Reducing or eliminating the tax hit is a primary reason to have life
insurance later in life. At a younger age, life insurance plays a key role
to replace income that may be lost due to premature death, sickness, or
disability. However, once the need for income replacement has been
eliminated – perhaps because income from employment is no longer being
received – then it is time to assess estate plans and how life insurance
can facilitate wealth transfer.
A life insurance policy can be issued as a personal policy or a joint
policy. A personal policy covers the life of one person, while a joint
policy covers two people, usually spouses. A joint policy can be issued in
two forms: joint-first-to-die and joint-last-to-die. If two spouses wish to
have insurance, it may be less expensive to acquire the insurance
in a joint policy than two separate personal policies. However, it is wise
to obtain quotes on both – as separate policies and as a joint policy.
When a policy is issued as joint-first-to-die for two spouses, and one
spouse dies, the surviving spouse receives the death benefit of the policy.
When the policy is issued as joint-last-to-die for two spouses, and one
spouse dies, the other spouse receives nothing from the policy. Eventually,
when the survivor dies, the death benefit of the policy is paid out. It can
be paid to the estate if a beneficiary or beneficiaries are not named in
the policy, or directly to beneficiaries if named.
When insurance proceeds are received by the estate, the proceeds become
part of the total estate value on which probate fees are based. However,
this can create or supplement the pool of funds needed to pay debts and
taxes owed by the deceased. Any money remaining after clearing debt can
then be paid to the beneficiaries named in the will.
When the insurance proceeds are paid to beneficiaries named in the policy,
they receive the proceeds tax-free. Also, because the benefit is received
by the beneficiary and does not become part of the estate of the deceased,
it bypasses probate.
How the beneficiary uses those proceeds is entirely his or her choice. He
or she could use them to eliminate capital gains tax on a property being
inherited from the deceased. If ample money exists in the estate to pay the
tax, the beneficiary just might hold onto their windfall in its entirety.
Property, in this instance, is any capital property owned by the deceased
on which capital gains could be charged, such as real estate, an investment
portfolio of shares and bonds, jewellery or art.
Ultimately, why would a couple choose joint-first-to-die? The insurance
would be appropriate if there was any doubt about what would happen to a
surviving spouse after death of the other spouse. Is there is enough money
to pay for good-quality care for a spouse in later life? If not or if this
is uncertain, then having the insurance proceeds paid to the surviving
spouse gives each spouse peace of mind during their lifetime together for
the future. And funds that are not used during the lifetime of the
surviving spouse, for care or any other purpose, will form part of his or
her estate for distribution by will.
Joint-last-to-die is the choice to enable estate transfer by providing
funds for tax purposes. Of course, not all the money might be required for
tax. Once again, proceeds in excess of need can provide cash in the pocket
to the beneficiary to spend or save as he or she wishes.
Talk to your financial planner or estate lawyer about how best to
coordinate the benefits of life insurance for the most tax effective estate
Susan Yates, an expert in insurance products and planning, is founder and
president of the
Centre for Life Insurance and Financial Education (CLIFE), providing continuing education courses to insurance agents and
financial planners. She is co-author of
R.I.G.H.T. Answers: Answers to 260 of Your Retirement Questions.
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