Advanced Life Insurance Planning Strategies

Sometimes complex financial needs call for complex financial planning. Perhaps your assets are substantial and complicated, or you own your own business. You can work with financial advisers and lawyers to use life insurance in legal arrangements that give you more control, reduce potential taxes, and accomplish more of your goals.

Life Insurance Trusts

By assigning ownership of your policy to an irrevocable life insurance trust (ILIT), or by having the trust purchase the policy with money you gift to it, you can take the death benefit out of your estate and maintain control over how it’s used. You must give up complete ownership to remove the policy from your estate. If you think you may need to use the cash value or want to reserve the right to change beneficiaries, you probably don’t want an ILIT.

But, by assigning ownership to a life insurance trust, you gain another kind of control: the ability to specify how the trust distributes the death benefit. If you want part of the death benefit to fund your child’s college tuition, you can instruct the trustees to maintain funds for this purpose. You can also leave the death benefit money in the trust with instructions to provide income to your spouse or partner, which keeps the assets out of his or her estate. However, establishing an ILIT is something you don’t want to do without legal and tax advice.

Buy-sell Agreements

One of the biggest investments you ever make could be in your own business. You might own a business by yourself, with a partner, or as a closely held corporation, which is owned by a limited group of stockholders. If so, your death could throw the company’s future into uncertainty. Discussions could turn into long legal battles that sour relationships and drain money from the business and your beneficiaries. To make the transition easier, you can work with an attorney to create a business continuation plan, which irons out what happens to a company if an owner dies.

One popular business continuation plan is a buy-sell agreement funded with life insurance. There are several ways to structure a buy-sell agreement. Basically, the agreement ensures that if an owner dies, the surviving owners must buy the deceased person’s share of the business at a set price. For example, suppose you own a business with a partner. Your buy-sell agreement could set the value of each share of the business at $500,000. Each of you would buy a life insurance policy on the other’s life with a death benefit of $500,000. That way if you died, your business partner would immediately have the money to buy out your share of the business, and vice versa.

You can also set up a buy-sell agreement with a chosen successor, such as an employee or relative you trust to run the business after you’re gone. In that case, your successor would be the owner and beneficiary of a policy on your life that pays out enough to buy your share of the business at your death. Here, too, you’ll want professional advice before signing any documents.

Key Employee Insurance

What if one of your employees is so valuable and irreplaceable that his or her death would spell financial disaster for your company? You can buy life insurance on a key employee to protect your business from that financial risk.

Just remember to approach your employee first. Most states require either that you notify your employee about the reasons for the insurance coverage or that you get your employee’s written consent.

Deferred Compensation

Deferred compensation is a way to offer an incentive for employees to stay with your company. Unlike benefits such as a 401(k) plan, deferred compensation isn’t a qualified plan. You can offer it to some employees and not others and choose when to start paying benefits.

For example, you may have a wellcompensated employee you’d hate to lose. You can set up a plan in which she agrees to freeze her salary in exchange for $5,000 a month after age 65. By forgoing raises, she stays in a lower tax bracket.

To make this plan work, you can buy a large permanent life insurance policy on her life. When she retires, you use the cash value to pay the deferred compensation. If she dies before retirement, her beneficiaries get the death benefit. However, if she resigns, she forfeits the future income. That’s why deferred compensation is sometimes called golden handcuffs.

Tax rules that apply to arrangements like this are complex, though, so be sure to consult a qualified adviser.