Are You Overlooking This Key Element in Life Insurance Planning for Your Clients?

Life insurance is one of the most versatile tools in financial planning, offering a wide range of benefits that encompass tax planning, estate planning, retirement planning, business continuity, and more. While much of the discussion around life insurance focuses on selecting the right type of policy and coverage amount, an equally important yet often overlooked aspect is how the policy’s ownership and beneficiary designations are structured.

 The Importance of Proper Ownership and Beneficiary Designations

Designing a life insurance policy goes beyond choosing a product; it requires careful consideration of who owns the policy and who benefits from it. These decisions significantly impact the policy’s effectiveness in meeting financial goals, such as providing liquidity, reducing estate taxes, or ensuring a smooth business transition.

For businesses, the ownership of a life insurance policy can vary based on the intended use. For example, when a policy is used as part of a buy-sell agreement, the ownership structure might differ:

 In a Redemption Agreement, the business typically acts as both the owner and beneficiary, ensuring that the business has the necessary funds to buy out a deceased partner's share.

In a Cross-Purchase Agreement, each business owner may hold a policy on the other, with each owner being the beneficiary of the policy on their partner. This setup ensures the funds are available for each partner to purchase the deceased partner's share directly.

 When a policy is intended to protect against the loss of a key executive, the business should both own the policy and be its beneficiary. This arrangement ensures that if a key leader is lost unexpectedly, the business receives the proceeds to help cover the financial impact. Similarly, providing life insurance as part of an executive compensation package adds complexity, as the ownership could be with the business or the executive, depending on the desired tax outcomes. This requires careful planning to align the policy structure with the company’s overall financial strategy and objectives.

 For individuals, the ownership and beneficiary structure of a life insurance policy can have profound implications for estate planning. For instance, if the goal is to keep the policy proceeds out of the taxable estate, the policy should not be owned by the insured. Instead, ownership might be assigned to an Irrevocable Life Insurance Trust (ILIT) or even directly to the children, thereby excluding the death benefit from the estate.

 However, if keeping the proceeds out of the estate remains a priority, an ILIT or another third party should own the policy. For policies designed to provide living benefits, such as those with chronic illness riders or those intended for cash value accumulation, ownership decisions become even more critical. Typically, the insured would own the policy to maintain access to living benefits. However, if the policy is meant to remain outside the estate, ownership by a trust would be more appropriate.

 Choosing the Right Beneficiary

Determining who the beneficiary of a life insurance policy should be is as crucial as deciding on ownership. For policies involved in buy-sell agreements, the beneficiary designation must align with the agreement's terms. In the case of key person insurance, the business is usually the designated beneficiary to ensure it receives the necessary funds to cope with the financial impact of losing a key employee. For estate planning purposes, naming a trust as the beneficiary can help keep the proceeds out of the taxable estate.

 In contrast, for income replacement purposes, a spouse or children might be named as beneficiaries.

It’s also essential to consider contingent beneficiaries to avoid potential probate issues, especially if the primary beneficiary predeceases the insured. If the policy’s primary beneficiary is a trust, the choice of contingent beneficiaries may not be as critical, but it still requires careful thought to avoid unintended consequences.

 Conclusion: Crafting a Comprehensive Life Insurance Strategy

Life insurance is often referred to as a Swiss army knife in the realm of financial planning due to its versatility. However, its effectiveness is largely determined by the proper structuring of ownership and beneficiary designations. It is vital to pause and ask ourselves: Who should own this policy, and why? Who should be the beneficiary, and why? These decisions are not just about optimizing the policy’s current use but also about safeguarding its intended benefits over the long term.

 As we assemble the various pieces of this planning puzzle to align with our clients' goals, it is crucial to regularly review these key elements. If you have any questions or need guidance on structuring your life insurance policies to better support your broader financial objectives, feel free to reach out.

Thank you for reading, and stay tuned for more insights in our next newsletter. Feel free to take advantage of our no-cost resources: Visit the Legacy Planning Academy, as well as our complimentary weekly one-hour coaching sessions every Wednesday at 9 AM Pacific Time.  Sign up using this link Coaching  Coaching Registrations.