Should your spouse be your life insurance beneficiary? - Rodgers & Associates

Should your spouse be your life insurance beneficiary?

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In most instances, the likely primary benefi­ciary of a life insurance policy is a spouse. But does this make sense given the special tax treatment life insurance receives in estates?

The special treatment is that life insurance proceeds are not taxable to heirs even if the heir is the estate. The tax we are talking about is the PA inher­i­tance tax at 4.5% to lineal descen­dants such as children or parents, 12% to siblings, and 15% to others (excluding charities). Because of this special tax treatment, some poten­tially valuable strategies should be considered.

Naming children as the primary life insurance beneficiaries

The first strategy is to name the children as primary benefi­ciaries if the spouse is finan­cially secure. Being finan­cially secure is a subjective condition, so you will need the help of a financial adviser to determine if this is so.

Some clues to deter­mining financial security are pension and fixed income streams more than satisfy expenses, potential long-term care costs being managed either through Long Term Care Insurance, or if they are a current resident at a Life Care or Continuing Care Facility.

The reason this strategy makes sense is that if the spouse is the primary benefi­ciary they receive the insurance death benefit tax-free. When these monies are inherited by the children they will have to pay the 4.5% PA inher­i­tance tax. Why not have the children receive the monies as a primary benefi­ciary without having to pay the tax, since this is most likely the final desti­nation of the funds?

Utilize non-lineal heirs as life insurance beneficiaries

The second strategy is to use life insurance benefits to provide for non-lineal heirs such as siblings or other non-related benefi­ciaries. The benefit with this strategy is that life insurance proceeds are received tax-free. Since the PA inher­i­tance tax is much higher for siblings (12%) and others (15%), this signif­i­cantly increases the net inher­i­tance to people in this category.

Should the life insurance benefit received by the spouse serve only to inflate the estate beyond the 2016 federal estate exemption of $5,450,000, consider naming an Irrev­o­cable Life Insurance Trust (ILIT) as the beneficiary.

Life insurance has the unique oppor­tunity to provide tax-free liquidity to the benefi­ciaries who receive it. Don’t overlook this special attribute when planning for the transfer of your wealth.