By: The American Academy of Estate Planning Attorneys
Insurance might not be the first thing that springs to mind when someone mentions estate planning. We tend to associate estate planning with Wills, Trusts, and taxes more than with declaration pages and policy terms.
However, insurance serves two important estate planning functions, and without it, your plan might not be performing to its potential. The core purpose of insurance is to reduce risk, protecting your bank account and preserving your estate in the face of unexpected catastrophe. Whether or not catastrophe strikes, insurance has special characteristics that allow you to position your estate for sophisticated planning. Let’s take a look at the basic types of insurance and how they strengthen your estate plan.
Coverage for You and Your Family
There are three kinds of insurance designed to protect you and your family in case of illness, disability, and death. Health insurance defrays the cost of medical bills and prescription drugs in case of injury or illness. Disability insurance – an option overlooked by many – replaces a portion of your income if you are ill or injured and unable to work. Life insurance pays a death benefit to a beneficiary of your choosing, and the funds can be used for any number of purposes. This makes it an important planning tool for young families or for anyone who has financial responsibilities that outweigh their accumulated financial means.
Coverage for You Home
If you own your home, homeowner’s insurance covers damage to the structure of your house from fire and other causes. It also protects you against theft or damage to the contents of your home, as well as lawsuits brought by people injured on your property. If you rent your home, renter’s insurance covers damage to the contents of your house.
Most homeowner’s insurance policies do not cover earthquake or flood damage; you must buy additional coverage for these risks.
Title insurance provides an entirely different kind of protection. Rather than covering damage to your house, it protects your ownership interest in the property. If someone else claims ownership of the property, a title insurance policy helps you defend against the claim and pays you for any loss of ownership.
Coverage for Your Vehicles
If you operate any type of vehicle – a car, a boat, a motorcycle, or an airplane – you need insurance coverage. Vehicle insurance can protect your property and provide coverage for any liability arising from your use of the vehicle.
An umbrella policy is insurance that goes over and above other insurance policies you maintain. Let’s say you have an auto insurance policy that provides $300,000 in coverage and an umbrella policy that provides $1 million in coverage. If you’re in a car accident and cause $500,000 in damage, your auto policy will pay the first $300,000 and your umbrella policy will pick up the remaining $200,000.
Insurance and Your Estate Plan
Used together, these coverages serve as a safety net for you and your family. They protect the property you’ve worked hard to accumulate. Going a step further, life insurance can be used as a simple and effective estate planning tool. During your lifetime, its value remains low. After your death, however, if you own the policy, the death benefit is included in your estate for estate tax purposes, even if someone else is named as the beneficiary.
If you choose a death benefit that, combined with your other assets, is greater than the estate tax exemption at the time of your death, ($5.340 million federally and $1 million in Oregon in 2014), you would owe estate taxes without further planning. You could avoid estate taxes on the insurance by establishing an Irrevocable Life Insurance Trust (“ILIT”) and transferring the policy to the Trust. Then, at your death, the insurance proceeds could flow to the beneficiaries of the ILIT without diminishment from estate tax.