Life insurance in estate planning

The liquidity problem

Estates holding a business, farmland, real property or a collection have value but not cash. Obligations, taxes where they apply, and equalising payments to heirs all need money on a timetable the assets can't meet.

The alternative is a forced sale — usually at a discount, sometimes of the thing the family most wanted to keep. Insurance is the standard answer to that specific problem.

Equalising an inheritance

Where one child will take over a business or keep a property, insurance can fund an equivalent inheritance for the others without breaking up the asset.

This works better than dividing an asset several people then have to co-manage, and it prevents the disputes that follow from that.

Ownership and incidents of ownership

Where the insured owns the policy — or holds incidents of ownership such as the right to change the beneficiary, borrow against it, or surrender it — the death benefit is generally included in the taxable estate.

That inclusion can be exactly what you were trying to avoid, which is why the ownership question comes before the coverage question.

What an ILIT does

An irrevocable life insurance trust owns the policy instead of you. Because the trust owns it and you don't hold incidents of ownership, the death benefit can generally sit outside your estate while still being available to your beneficiaries.

The trust also controls timing and terms — useful where beneficiaries are young, or where you want the money released over time rather than at once.

• The trust must be properly drafted and genuinely irrevocable
• Premium funding usually involves gifts to the trust, with their own reporting rules
• The trustee must actually administer it, including required notices
• Retaining too much control can defeat the purpose entirely

The three-year rule

Transferring an existing policy into a trust doesn't take immediate effect for estate purposes. If the insured dies within three years of the transfer, the death benefit is generally pulled back into the estate.

The implication is practical: it's usually cleaner for the trust to apply for and own a new policy from the outset than to transfer an existing one. If a transfer is the only option, do it as early as possible.

Sequence this correctly

• Estate attorney first — the structure determines everything after it
• Tax adviser on funding, gifts and reporting
• Then apply for coverage, with the trust as applicant and owner where that's the plan
• Review after any change in family, assets, or tax law
• Check that beneficiary designations match the plan rather than contradicting it