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Napa Valley Wealth Management - St. Helena, CA

4 Strategic Uses of Life Insurance to Create & Preserve Wealth

| July 30, 2019
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When you hear the words life insurance, do images of 1970s salesmen come to mind? Life insurance products have significantly changed and today are cheaper and more flexible than 10 years ago. Life insurance can help you generate extra money, prepare for your businesses succession, save income and estate taxes, and sometimes even replace money you've given away. If you bought insurance before 2000, it's a good time to look again.

Let's talk about four strategic ways life insurance can help you create and preserve wealth.

1. Business Owner's Succession Plan: Protect Your Business and Family with a Buy-Sell Agreement

As a business owner, if you unexpectedly became disabled or passed away, what would happen to your business and the income for your family? Succession planning is one of the biggest challenges business owners face, but without planning, the chances of a company surviving the loss of an owner are slim.

Enter the buy-sell agreement funded by life insurance. Here’s how it works: First, choose a successor, like a key employee. Then, draft a buy-sell agreement that defines the business’s value—one that you and the successor agree will be a fair price for him or her to buy the company should something happen to you. This will pre-establish the sale price for when the agreement kicks in and will help prevent your heirs and your successor from a potentially tricky situation later. The value/sale price can be either a number (i.e., $1 million) or a formula that will be used to calculate the value and sale price when the agreement is invoked (i.e., 3x revenue). The successor will purchase a cash-value life insurance policy on you equal to the fixed or estimated sales price. Upon your death, the life insurance will pay out to your successor, who will use the money to buy the business, from your heirs or other ownership entity, at the value established in your agreement.

Most of us cringe at the thought of life insurance, so let's talk about strategic ways life insurance can help you create a preserve wealth.

Example: Buy-Sell Succession Plan Funded with Life Insurance

Tom spent ten years building a successful boutique winery. His wife and children are not involved in the business and have no training or experience, so he’s concerned about the future of his business and his family's income should something happen to him. 

Tom chose his key employee, his winemaker Felipe, as his successor in the event something catastrophic should happen. Tom and Felipe agreed on a future sale price of $1 million and created a buy-sell agreement: then Felipe purchased a life insurance policy on Tom for $1 million. Should something happen to Tom (don’t ask about the Great Grape Incident of '08), Felipe would use the life insurance proceeds to buy the business at the pre-established price of $1million. This will ensure that the business continues after Tom’s death and will providincome for his wife and children from the business sale. 


Read Related: How to Protect Your Business from the Loss of a Key Employee
Read Related: 
Insuring Your Business With a Buy/Sell Agreement


2. Use Life Insurance to Pay Estate Taxes (and Help Your Heirs Avoid Selling Assets)

If your estate is valued higher than the federal estate tax exemption ($11.4 million in 2019), your heirs could owe federal and state estate taxes on their inheritance. Any illiquid assets—think business or property—are included in your estate’s total value calculation, so it could be larger than you think.

As of this 2019 writing, federal estate taxes are a minimum of 40%. Your heirs could also see upwards of a 60% estate tax tacked onto any of your retirement plans funded with pre-tax dollars.

Tax laws change regularly, as do the minimum estate tax exemption thresholds. Not planning for how your family will pay estate taxes could lead to their selling a business or other hard asset that they hadn’t planned on—all to create the liquidity needed for Uncle Sam. Life insurance can help.

Example: Paying Estate Taxes and Expenses with Life Insurance in Trust 

Mr. and Mrs. Smith’s estate is valued at $20 million, and the majority ($16 million) consists of the illiquid assets of a family business and real estate. Since the estate is larger than the current estate tax exemption, their heirs will likely pay estate tax on assets above the exclusion, or $8.6 million ($11.4 million-$20 million). At a 40% estate tax, their bill would total $3.4 million. Where will they get that kind of cash without selling either the business or the property? 

Enter the Irrevocable Life Insurance Trust (ILIT) that purchases life insurance. 

How to Set Up and Use an ILIT 

First, the Smiths would set up an ILIT trust outside of their estate (one that’s owned by their children or a third-party beneficiary, not by them personally). Then, the couple would put money into the trust. They could fund it by contributing gifts to their beneficiaries into the trust. If these gifts are lower than the annual gift exclusion (currently $15,000), they’ll avoid possible estate tax triggers on any cumulative lifetime gifts.

Now funded, the trust would purchase a life insurance policy that will pay out to the heirs after the Smiths pass away. The heirs could use the policy’s proceeds to pay estate taxes and settle any other estate expenses smoothly and efficiently.

Using an ILIT to purchase life insurance will accomplish three things:

  1. The value of the life insurance will not be included in your estate value calculation. If you were to own the insurance, its cash value and possibly the death benefit would be included in your estate’s total value calculation.
  2. You still retain control. Worried your heirs might skip payments or try to cash out the value early for a Ferrari? While in trust, you still retain control.
  3. Tax-free inheritance: Life insurance is passed to your heirs tax-free—they won’t owe income tax on the payout.

Read More: Benefits of Life Insurance


3. Replace the Money You Donated to Charity

When crafting estate plans, some people struggle between giving to charity and leaving money to their family. Life insurance can help you balance both goals. Here’s how.

Instead of leaving cash or assets in your will, consider a Charitable Remainder Trust (CRT) to distribute your legacy gifts. With a CRT, your donation is placed in a trust and invested. You receive a tax deduction for the donation and, while you are still alive, income from the investment. Upon your passing, the remainder of the assets in the trust will go to the charity you've designated.

Many people are familiar with CRTs, but here's the difference: If you purchase a life insurance policy with the income generated from the CRT, when you die, your family will receive the insurance death benefit, which will effectively replace the money you gave to charity.

Example: Fund Your Legacy Plan with Trust Life Insurance

Mr. and Mrs. Jones would like to leave some of their $3 million estate to their favorite charity. They create a CRT, they fund it with $1 million, and the CRT pays them $50,000 a year in income. When Mr. and Mrs. Jones pass away, the proceeds of the trust will pass to the charity. Meanwhile, the Joneses used the annual income they received from the trust to buy a $1 million life insurance policy with their heirs as the beneficiaries, thus replacing for their heirs the amount given to charity.

4. Insure Your Income

Jane is a successful executive in her 40s. Her career is on track; she makes a healthy six figures, and with young kids, she plans to work another 15 years. She has it all together, but she’s unknowingly carrying a risk for her family.  

Most successful professionals in their 40s are underinsured. Jane makes $200,000 per year. If anything were to happen to her before retirement, her family’s revenue stream would vaporize. Over 15 years of her planned working years left, that’s $3 million of revenue. The solution: Jane needs to ensure her income up until she plans to retire. Term insurance can be an inexpensive solution that would provide for her children and their education and her spouse should the worst happen.

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At Napa Valley Wealth Management, we use advanced financial planning scenarios to help our clients plan, build, and preserve their wealth. Have questions about how life insurance can help you accomplish your tax minimization, estate planning, or business succession goals? We offer a complimentary consultation and would be happy to meet with you over the phone or in one of our offices. 

Certified Financial Planning Service in Napa Valley California and Walnut Creek California 


Categories: Life Insurance, Charitable Giving, Business Owners


This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.

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