Is Insurance a Wise Purchase for Estate Liquidity?

When I started practicing law more than thirty years ago, the federal estate tax exemption amount was only $600,000. Nearly everyone with any means bought life insurance to cover estate taxes. To exclude the insurance from the estate, clients typically created an irrevocable life insurance trust (ILIT) to own the policy. When the client passed away, the insurance provided liquidity to pay estate taxes so the family wouldn’t have to sell off other assets such as homes, stocks, land and family businesses.

Today, the federal estate tax exemption is $12.06 million so only those with significant wealth believe it necessary to provide liquidity to pay estate taxes.

Two questions – will the exemption remain this high? Are there other reasons besides estate taxes to purchase insurance?

While it’s true that today’s federal estate tax exemption exceeds $12 million, without further legislation enacted by Congress and signed by the President the law sunsets on December 31, 2025. Consequently, in 2026 the exemption will fall to $6.5 million. Whether new legislation is enacted is anyone’s guess and largely depends upon the political situation between now and then.

Even if the estate tax is not a liquidity problem for your estate, there are other reasons to purchase insurance to provide much needed liquidity. Retirement accounts such as IRAs and 401(k)s are frequently a large portion of client’s net worth. Withdrawals from those accounts are taxed as income to the account owner. When you die and leave your retirement account to your beneficiaries, the same holds true.

If you’re one of the lucky ones who don’t need your IRA for living expenses, it might make sense to use your required minimum distributions to pay for a life insurance policy. That way, you’re converting dollars that will be taxed into tax-free distributions for your loved ones.

Those in blended families may also consider liquidity needs. Assume that Joe is married to Nancy. This is the second marriage for each. Nancy is not the mother of Joe’s children. If Joe leaves Nancy his assets in a marital trust for the rest of her life, and Nancy lives to be ninety years old or more, Joe’s children may be in their seventies before they inherit anything from Joe’s estate.

The marital trust ties Nancy to Joe’s children economically for the rest of her life. Every dollars she spends is one less dollar that Joe’s children will receive. Joe may wish to consider a life insurance policy that pays his children when he dies. This way, they inherit something at his passing, and he can leave Nancy his assets outright so that there’s no tug of war over his estate.

This is especially true when Joe’s estate consists mainly of qualified retirement accounts like IRAs and 401(k)s. When Joe names Nancy as his primary beneficiary, Nancy rolls over the account into her own name. She can then choose the beneficiary of the account. If Nancy has children and names them, Joe’s children will not inherit unless Joe leaves them other assets, such as life insurance.

Other reasons to consider life insurance is when most of the estate is illiquid, such as real estate investments, business interests and home values. Here the surviving spouse may have a healthy balance sheet, but her liquidity needs may surpass the income that she receives, especially if her decedent spouse’s pension is reduced or even eliminated entirely on his death. Often, I’ve seen circumstances where the decedent thought that he was leaving his spouse a healthy retirement only to find that she doesn’t have the liquidity necessary to support her lifestyle.

One last thought. If you own a life insurance policy through an ILIT and it doesn’t make any sense to do so, are there options available to you? Yes, there are many. This depends largely on the terms of the policy itself, its current cash value, the terms of the trust, and your current estate planning goals. So, if you’re reluctantly paying premiums because you feel you don’t have any other choice, or if you have a paid-up policy that languishes inside of an old trust that isn’t relevant any longer, that’s something that can be explored and often rectified.

©2022 Craig R. Hersch,  Sheppard Law Firm Learn more at

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