By Matt Lewis, CLTC, Vice President, Insurance
Life insurance is designed to provide for your loved ones after your death, giving you peace of mind that their financial needs will be met without your income. But life insurance can benefit your financial planning in many other ways.
For individuals, a permanent life insurance plan can play a key role in estate planning by helping reduce estate taxes. For small business owners, it can protect key employees, provide executive benefits, and help preserve business ownerships. Let’s look in more detail at the different ways to use life insurance.
Offset Taxes in Estate Planning
Estate taxes can be a problem for high-net-worth individuals passing on more than the IRS estate tax exclusion, after which the tax rate on transferred money is 40%. As of 2023, that exclusion is $12.92 million ($25.84 million for couples), but it will revert to its pre-2018 level of $5 million (adjusted for inflation) in 2026.1,2 Some states have an estate tax as well, and they may have a lower threshold for when the tax applies.3
If you’re concerned about an estate tax burdening your heirs, you can use life insurance to provide cash to your beneficiaries to help offset the costs. With life insurance funds, they will not need to decide which assets to pay to cover their tax bill. A federal estate tax is due within nine months of the date of death, and a life insurance policy would provide a payout well before then.4
Life insurance can also play a role in estate planning as you develop your charitable giving plans. You can use life insurance to pass on a tax-free death benefit to a charity or a cause instead of allocating that money to family members.
Protecting the Value of Key Employees
Life insurance can also protect against the loss of valuable employees. A business is likely to face economic loss if it loses a key employee, such as someone who operates the business or someone who plays a pivotal role in developing it. A business could suffer a number of negative effects from losing a key employee, including lower sales, disrupted production, and missed business opportunities.
If you’ve invested substantial time and money in an employee’s development, replacing them could be costly, especially if they have years of experience and knowledge. Taking out a life insurance policy on that key person can help you offset some of the costs of replacing them.
If the business ultimately does not need to use the insurance policy (if the employee doesn’t die while they’re employed), it can use the cash value toward other purposes like business goals or to provide deferred compensation or retirement income for the employee.
Businesses that use this life insurance strategy must get the employee’s approval in writing. They must disclose the terms of the policy, including the insurance amount, and ensure that the employee understands that the business will be the beneficiary.
Providing an Executive Benefit
Businesses can also use life insurance as an executive benefit or as part of a bonus program that provides executives with access to the cash values in addition to the life insurance benefits. This strategy can be used to retain and reward executives or other key members of your business.
To use life insurance as an executive benefit, the employer would fund the policy with enough money to generate long-term gains. Essentially, the policy would not provide an instant benefit, but would instead provide an income stream for the employee in the long-term, perhaps in retirement.
The employee would be in control of the policy and have access to the cash values. Then, they could keep the life insurance when they leave the company. Employers can offer life insurance in this way in addition to other benefits like 401(k) plans.
Keep in mind that with an executive bonus plan, you would need to have a legal agreement in place explaining how the life insurance funds are to be used.
Funding a Buy-Sell Contract
In a buy-sell strategy, business owners can protect their interest in the business using a buy-sell contract funded by life insurance to prevent outsiders such as heirs from running or selling the business when one owner dies.
If one business owner dies, the other business owner or owners could use the life insurance funds to buy that partner’s stake in the company, rather than sharing ownership with the deceased partner’s family members.
To use life insurance with a buy-sell agreement, you first need to work with an attorney to draft a legal buy-sell agreement that specifies the terms of the sale of the business interest. Then, life insurance would serve as a funding source to buy that business stake and so that it remains under the control of the current owners. Essentially, the buy-sell agreement funded with a life insurance benefit can minimize conflicts and help ensure a smooth business transition.
The Bottom Line
Life insurance can provide valuable financial security to beneficiaries, but it can serve many other purposes as well, from helping offset estate taxes to protecting against the loss of a key employee. Consider consulting with a professional financial advisor for more advice on how to use life insurance to meet your specific financial goals.
[1] IRS. “Estate Taxes.”
[2] IRS. “Estate & Gift Tax FAQs.”
[3] Tax Foundation. “Does Your State Have an Estate or Inheritance Tax?“
[4] IRS. “Filing Estate and Gift Tax Returns.”
Matt Lewis is a non-producing registered representative of Cetera Advisor Networks LLC.
The cost and availability of life insurance depend on factors such as age, health, and the type and amount of insurance purchased. Before implementing a strategy involving life insurance, it would be prudent to make sure that you are insurable by having the policy approved. As with most financial decisions, there are expenses associated with the purchase of life insurance. Policies commonly have mortality and expense charges. In addition, if a policy is surrendered prematurely, there may be surrender charges and income tax implications.
