Life insurance for estate planning

Most people want their estate plan to address a few key things, including distributing their assets, covering the cost of long-term care or a funeral, and providing for loved ones when they’re gone.

Life insurance can support all of these estate planning goals. Read on to learn how to use a policy to set up your heirs for financial success.

What is estate planning and why can life insurance help with it?

An estate plan refers to the legal documents that specify how you’d like your estate distributed after you pass away, or if you become unable to take care of yourself and your finances. 

Life insurance provides a way to easily designate a lump sum to your beneficiaries as part of your estate planning. They’ll be able to access the money without going through probate court, which can be a lengthy process.

This way, your loved ones won’t have to worry about any lost income and they’ll have funds available to cover final expenses and any outstanding taxes.

The three basic routes to create an estate plan are to use an online service, work with an estate planning attorney, or create a plan yourself using online templates. It’s important to have an estate plan no matter how much you own, so that your beneficiaries can inherit your assets smoothly.

How is life insurance used in estate planning?

If you’ve saved up for end-of-life expenses, the death benefit from a life insurance policy can become a nest egg for your loved ones. 

For high-net-worth individuals, life insurance is one of the tools you can use to manage your estate taxes.

Main benefits of life insurance in estate planning

• Quick financial support to beneficiaries. Life insurance provides a way for your beneficiaries to receive relatively quick financial support. When the insured dies, the beneficiary can file a claim with the insurance company and receive the benefit in as little as two weeks. 

• Easy access to funds to cover financial obligations. The liquidity of a death benefit can help cover final expenses and any outstanding tax obligations relatively quickly. A policy’s death benefit can bypass probate court. This can become a lengthy process especially when a significant estate is involved, which may delay any access to funds from the estate.

• Tax-free inheritance for your family. Beneficiaries also don’t have to pay income tax on the death benefit like they would with other assets, like traditional retirement accounts.

Estate taxes payment

While the death benefit generally isn’t taxable, the benefit amount is factored into the overall value of your estate in some circumstances.

High-net-worth individuals can create an irrevocable life insurance trust, or ILIT, to remove a policy from being counted as an estate asset.

If your estate does owe taxes, it might be enough for your beneficiaries to apply some or all of the death benefit toward the tax, then financially support themselves using the assets distributed in your will.

Preserving family assets

Estates valued at less than $12.92 million are not susceptible to federal estate tax, but some states have lower thresholds. [1]

At the time of your death, your executor will have to pay any outstanding taxes. High-net-worth individuals may choose to fund permanent life insurance policies — which don’t expire and usually have a cash value savings component — as a way to preserve assets in a way that will minimize estate tax.

Estate equalization

As long as it’s paid in a lump sum, the death benefit passes to your beneficiaries tax-free after you die.

You can designate portions of your policy’s death benefit to any of your loved ones who might need financial support when you’re gone. That could be your parents, your children, or loved ones who might need specialized care into adulthood. 

Life insurance is an easier way to achieve estate equalization as opposed to other assets, like real estate, that are harder to divide between beneficiaries.

Special considerations when using life insurance in estate planning

Family members with a disability

A life insurance policy can be a valuable part of your estate plan if you have a child or family member with a disability.

If you have a dependent who’ll likely need long-term care, a permanent policy — which never expires — may be a good fit to ensure their financial protection. 

You may also want to designate a special needs trust as a beneficiary for your policy. This way, your chosen trustee will be able to distribute funds to your family member without disqualifying them from getting Social Security or Medicaid benefits.

→ Read more about life insurance for people with a disability

Blended families

Estate planning can be especially important for blended families to ensure that each party is included as intended. It’s not recommended to list minors as beneficiaries on life insurance policies because they can’t legally claim the benefit.

In that case, a trust can be a good solution to designate assets to both a surviving spouse and children. This ensures your children or step-children are not left out of the inheritance.

If you already have a policy and go through a divorce or separation, you can change the beneficiaries at any time. You’ll just need to contact your insurance company.

Family businesses

Life insurance can also aid in keeping family businesses running if a key partner were to pass away. Buy-sell agreements are contracts that determine how a deceased partner’s share of the business is to be redistributed — these contracts are often funded by life insurance policies.

In this case, the death benefit can help the surviving partner or family member maintain their control of the business.

→ Read more about life insurance for business owners

Charitable organizations

Some people wish to include charitable contributions in their estate plan. Life insurance can help achieve this goal, too.

You can outline your wishes in a trust that will serve as your beneficiary, and some insurance companies have provisions in place that allow you to select a charitable organization to support if your death benefit pays out.

What types of policies can be useful in estate planning?

Term

If you’re concerned with protecting your family while you’re in your prime working years, a term life insurance policy might be the best fit for you. Term is the most popular option for most people because it’s affordable, straightforward and only lasts for as long as you need it.

A term policy typically lasts for 10 to 30 years and provides financial protection while you have significant obligations, like young children or a mortgage.

Some people find that life insurance is less of a priority once they are retired since they can self-insure with the assets they already have. However, a term policy can be used for estate planning purposes later in life as well.

Permanent

If you have a higher net worth and are looking to maximize your beneficiaries’ inheritance, a permanent policy can be useful.

Permanent policies guarantee lifelong coverage and come with a cash value component that can accumulate over time. Your heirs can also claim the death benefit without paying income tax. 

Guaranteed universal life insurance

Guaranteed universal life insurance is a type of permanent policy that can help you build a tax-free inheritance for your family or supplement your retirement income.

It’s cheaper than other permanent coverage products such as whole life because it doesn’t accumulate as much cash value. Instead, it offers a guaranteed level payment and a death benefit payout. This payout can be used to cover estate taxes when the insured dies. 

Survivorship life insurance

Survivorship life insurance is a type of permanent coverage that covers two people — typically spouses — and pays out when both insureds die — that’s why it’s also called second-to-die life insurance. This type of policy is another way to provide a tax-free benefit for your loved ones and minimize estate tax.

What is the best life insurance for estate planning?

It depends on your estate planning needs. If you need lifetime coverage, a permanent policy is the best choice. If you simply want to leave behind an inheritance, a term life policy may be appropriate. Depending on your unique needs, you might want to consider other policy options. 

Below you’ll find our top coverage picks for estate planning.

• Best term life insurance: Transamerica

• Best guaranteed universal life insurance: Pacific Life

• Best permanent life insurance: MassMutual

• Best survivorship life insurance: Prudential

• Best for including charities in estate planning: Foresters Financial

Methodology: Best life insurance companies for estate planning in 2023

We don’t get paid for our company reviews and use an extensive rubric of criteria covering policy details, price, financial confidence, third-party ratings, and customer experience to assign unbiased ratings out of five stars. Any recommendations we make are based on internal and external expert opinions and data from our Policygenius Price Index, which uses real-time rate data from leading life insurance companies to determine pricing trends.

Our ratings and reviews can help point you to an insurer you can rely on for your family’s financial protection, but the best life insurance company for you is dependent on multiple factors. A licensed agent at Policygenius can work with you through the application process so you’re getting coverage from the best insurer for your circumstances at the most competitive price.

→ Read more about our reviews methodology here

Best term life insurance for estate planning

Why we picked it

Term products are more straightforward than permanent products, but they can still be useful for estate planning. Transamerica offers a policy with living benefits that includes terminal illness, chronic illness, and critical illness accelerated death benefit riders.

These riders — add-ons that can supplement a policy’s coverage under unexpected circumstances — allow the beneficiaries to request portions of the death benefit early to help in the event that critical end-of-life care is needed.

Best guaranteed universal life insurance for estate planning

Why we picked it

Pacific Life has high third-party financial ratings and competitive underwriting, along with a competitive guaranteed universal option. This is a solid option for estate planning since it provides a permanent death benefit at a relatively low cost compared to other types of permanent policies.

Best permanent life insurance for estate planning

MassMutual

3.8

Policygenius rating

How we score: Policygenius’ ratings are determined by our editorial team. Our methodology takes multiple factors into account, including pricing, financial ratings, quality of customer service, and other product-specific features.

MassMutual’s whole life insurance plan provides a lifetime coverage option that builds cash value with the potential to earn dividends.

Pros

• Strong financial stability ratings

• Potential for dividends 

• Offers a variety of permanent life insurance products

Cons

• No option to skip the medical exam

• High premiums

Read our full MassMutual review

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Why we picked it

MassMutual offers a wide range of permanent coverage products, including universal and variable universal life insurance policies. The company has high customer experience ratings compared to other carriers and consistently receives high third-party financial stability ratings.

Best survivorship life insurance for estate planning

Why we picked it

Prudential is another reputable company with strong financial ratings and nearly 4 million policyholders. Prudential offers a good option for those seeking a second-to-die or survivorship policy as part of their estate planning needs, which fewer companies offer since they’re not as common.

Best life insurance for including charities in estate planning

Foresters Financial

4.2

Policygenius rating

How we score: Policygenius’ ratings are determined by our editorial team. Our methodology takes multiple factors into account, including pricing, financial ratings, quality of customer service, and other product-specific features.

Foresters Financial offers a highly customizable term life insurance policy along with options for people who might want to skip the medical exam during the application process.

Pros

• No-medical-exam option available

• Very fast turnaround

• Unique riders included at no extra cost

Cons

• Slightly lower death benefits than other no-med options

• Rates slightly higher than industry average

Read our full Foresters Financial review

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Why we picked it

Foresters Financial’s term policy offering automatically includes a charity benefit provision at no additional cost. It provides that Foresters will pay an additional 1% of your coverage to a nonprofit organization of your choosing, which you can select at the time of application but change at a later time if need be.

How does an ILIT work, and how can it help in estate planning?

If you have a significant estate, an irrevocable life insurance trust (ILIT) can help offset the value of your policy so that your beneficiaries are not subject to estate tax. An ILIT shields a policy’s death benefit from estate taxes and probate. 

An ILIT also protects your assets from your beneficiaries’ creditors, in case they have other debt. When the death benefit is in an ILIT, it can’t be used to satisfy your beneficiaries’ debts or claims from creditors.

By protecting the death benefit from tax and debt liabilities, an ILIT can give you more control over how a beneficiary’s inheritance is spent.

→ Learn more about how life insurance works with wills and trusts

Should you have an ILIT?

If you want to protect the death benefit from your policy from tax liabilities and potential beneficiary debt obligations, you should consider having an ILIT.

The need for an ILIT can also depend on your state laws. Some states have a lower threshold than the federal standard for estate tax — for example, Massachusetts and Oregon impose taxes on any estate that’s worth over $1 million. [2]

In this case, your policy could push your estate over the minimum value to make it subject to taxes.

When deciding whether an ILIT is right for you, also consider its limitations. 

• An ILIT requires you to designate the trust itself as the policyholder so that it doesn’t count as an asset taxable to your estate. 

• You have to give up the ability to change the terms of your policy over time — changes can only be made through an appointed trustee. 

ILITs can also be expensive to set up since you’ll need help from an estate planning attorney. If you’re not sure which kind of trust is best for you, you should consult with an estate planning attorney to go over your specific situation and financial protection needs.

Other ways to use life insurance for estate planning

Life insurance isn’t just something for people with high net worths to consider. It’s important to have a plan no matter how much you own. Below are other ways you can use a policy in your estate plan. 

Final expense insurance

Final expense insurance is a type of permanent insurance in which the death benefit is meant to go toward end-of-life expenses. This type of policy doesn’t require a medical exam and remains in force as long as you pay the premiums, but the death benefit is lower than you’d receive through a term life policy.

Final expense policies don’t require the beneficiary to use the death benefit for final expenses, so make sure your beneficiary is aware of your intentions. Most people put the death benefit toward medical expenses and things like a burial, funeral, or casket.

Pre-need insurance

If you’re primarily concerned with burial and funeral costs, a pre-need policy essentially allows you to plan your funeral in advance. 

You enter into an agreement with a funeral home for their services at a set cost, so your loved ones don’t have to worry about the details or payments.

However, these plans usually cost more than other, more flexible policies and might not be honored if the funeral home closes or its ownership changes.

Do you need life insurance if you already have a will?

You might already have a will and testament set up to ensure your assets are properly distributed to your loved ones when you die, but even then, life insurance can still offer added benefits. While both offer financial protection to your family, they function very differently.

Life insurance is considered an income replacement and replaces any financial support you would have provided, whereas a will outlines assets you already have and how they’ll be divided.

If you already have a will in place, setting up a life insurance policy creates more robust financial security for your family and ensures their well-being when you’re no longer there to provide support.

How do wills and life insurance policies differ?

A will legally protects assets you already have, while a life insurance policy substitutes future financial support for your dependents.

A will and testament is a legal document that distributes your assets (such as property) and settles affairs (such as how you would like to be buried). A will can instruct what and how much inheritance your dependents receive from your estate.

A will also has a designated executor who serves as a legal proxy on your behalf after your death.

A life insurance policy is a contract between you and an insurance company that guarantees a death benefit for your beneficiaries when you die in exchange for the premiums you paid while you were alive.

Life insurance replaces future income and financial support that your beneficiaries were relying on and can be used to pay for anything from rent to your child’s college tuition.

Is life insurance part of your estate?

Life insurance becomes part of your estate if your named beneficiaries have predeceased you. If your primary beneficiaries and contingent beneficiaries aren’t alive or able to accept the death benefit, then the cash payout goes to your estate.

Life insurance proceeds are also considered part of an estate for tax purposes. That means the value of the death benefit is included in the valuation of your estate, and if it’s over the federal estate tax exemption ($12.92 million in 2023), estate taxes may be due. 

Estate taxes will ultimately decrease the size of an inheritance your beneficiaries receive, but proper estate planning with a trust can help avoid it.

What happens when life insurance goes to your estate?

When you die, a probate court determines how to distribute these assets using your will. Without a will in place, the court decides how to distribute your assets to your loved ones.

Because your estate is distributed according to your will and testament, if your life insurance policy is paid out to your estate as a last resort, then the money would be distributed according to your will.

Additionally, you may intentionally set up your life insurance policy to be paid out to your estate, though this isn’t usually recommended because the death benefit can then be collected by creditors to pay for any debts you owe before it’s dispersed amongst your estate.

How to avoid common mistakes in estate planning

Consider your assets and liabilities

It’s important to have an up-to-date list of your assets and liabilities so that you know exactly what your beneficiaries will inherit, or the remaining financial responsibilities they’ll have to cover. Your assets and liabilities will also determine which type of policy will be the best fit for your estate planning needs.

Talk to your family

Make sure your family knows about important estate planning components like a will and any policies that list them as beneficiaries. If they don’t know about your policy, they can’t make a claim if you die. 

Establish beneficiaries

Name beneficiaries who will need financial support when you’re gone. Many people list their spouse, children, or a family trust. 

Decide who should own the policy

In most cases, the insured should own the policy so that they can make any desired changes over the policy’s lifetime. However, when using an ILIT, the trust should be the owner of the policy for estate tax benefits.

Discuss with professionals

You should meet with an estate planning attorney in addition to a life insurance agent if you have significant estate planning needs or aren’t sure what type of policy is best for you.

Frequently asked questions

What role does life insurance play in estate planning?

Life insurance protects your loved ones after you die. Policy proceeds can be used to establish an inheritance or pay debts and estate taxes, or even minimize them through a life insurance trust.

Does life insurance create an immediate estate?

Yes. The proceeds of a life insurance policy pay out directly to the designated beneficiary and are immediately available for their use.

How do I keep life insurance proceeds out of my estate?

First, make sure you name a specific beneficiary as opposed to your estate. Next, you can create an irrevocable life insurance trust (ILIT) to own the policy and distribute the death benefit using a trustee. This way, the death benefit will not be included as part of your taxable estate.

Is life insurance considered an asset in an estate?

Life insurance claims go directly to the named beneficiary as opposed to your estate. They bypass the probate process that affects the rest of your estate. However, life insurance proceeds are considered part of an estate for tax purposes, so it’s important to check your state’s tax laws to confirm if this would impact your family.