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Using Life Insurance in Estate Planning

It’s no silver bullet, but it can help pay off debt, estate costs, and funeral expenses.

Farm families can use life insurance to smooth the bumps in a transition from one farming generation to another. Done right, it provides funds not subject to estate taxes. It can help farming heirs buy out at least part of a farm or ranch estate from their urban brothers and sisters.

“Life insurance is expensive, but it’s still a very good tool in the process,” says David Bau, a University of Minnesota Extension educator based in Worthington, Minnesota. “The farming heirs can have insurance on their parents, and they can use that money to buy out the estate.”

Most farm families couldn’t afford enough insurance to cover the increase in land values over several decades. “It would be pretty expensive,” says Bau, who specializes in agricultural business management and has written about life insurance in estate planning. But it’s a tool that can add fairness to the process and keep the farming business viable.

Another authority on life insurance, Montana State University Extension Specialist in Family Economics Marsha Goetting, doesn’t see life insurance as a very effective savings tool, however.

Term insurance covers death risk and increases in cost as the covered person ages. Whole and universal life policies include a savings plan along with the term insurance. They build value over time. With the savings plan added in, they cost more than term insurance, as well. 

“We don’t put a savings account with our auto insurance,” says Goetting. But whole life and universal life policies do work for some people. “The only way they will save is if they have something like a life insurance bill to pay,” she says.

Even though life insurance is far from a silver bullet for estate planning, it’s a tool that has many uses, which Bau and Goetting have outlined in Extension publications. They include the following.

  • Paying estate taxes. Even though fewer farm families are likely to be hit by estate taxes under federal tax reform, some states, including Minnesota, also have estate taxes.
  • Paying off debts, estate settlement costs, and funeral expenses.
  • Savings in whole life policies that can be borrowed to cover retirement or nursing home costs for the older generation (and also reducing proceeds that might go to heirs).
  • As mentioned, using insurance dollars to provide an inheritance to nonfarm heirs.

To get the intended benefits of life insurance, you’ll need careful planning with the help of an attorney, accountant, and insurance agent. Here are key pitfalls to avoid.

  • If you don’t want insurance proceeds to be included in a taxable estate, the heirs need to own the policy on their parents, for example. The heirs must pay for the policy, Bau says. Parents can’t write the checks for premiums, although they could use a gifting program to provide funds that heirs could use for premiums.
  • Families who haven’t started estate planning early enough may not even be able to use life insurance, especially if the older generation is in poor health. 

“There’s always the issue of whether you’re insurable,” Goetting says. “You put it off and you put it off, and you can’t get enough insurance to do a buyout.”

Goetting thinks that emphasizing the use of life insurance for paying estate taxes is misplaced for many farmers and ranchers whose businesses may not be worth as much as the nearly $22 million that a couple can now pass to a new generation tax-free. Instead, it should be part of an estate planning process aimed at providing a fair transition to a new generation.

“For the majority of us, we need to do estate planning to make sure what we’ve worked so hard to attain is passed on to the next generation,” she says, “and that the next generation is still talking to each other and willing to get together at Thanksgiving and Christmas.”

More in-depth information on life insurance and estate planning is available online from Goetting and Bau. 

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