How do I use life insurance for estate protection?

Life insurance policies are sometimes jokingly called an "instant estate," because having a life insurance policy, even term life insurance, creates a windfall for your survivors. However, having a life insurance policy is the first step in protecting your estate, and successful estate planning may include multiple life insurance policies of different types.

First, to keep the proceeds of your life insurance policy from being taxed, set the policy up as a trust. This means that the money contained in the policy is portioned out over time, eliminating taxation on the money. Trusts can be used to provide your survivors with monthly income, pay bills, or accomplish other tasks. In fact, a life insurance policy set up as a trust could be written to manage your estate for an indefinite period of time, from lawn maintenance to paying the utility bills.

Purchase different types of policies to accomplish different goals. Term policies are good for paying off the mortgage or providing a lump sum for your kids to go to college, but a whole life insurance policy is more effective in estate planning, allowing you set aside carefully defined values for different purposes. For example, one policy might pay off the mortgage, while another one sets up a trust to pay utilities and a third provides your surviving spouse with monthly income.

Estate taxes can eat up a large portion of an estate settlement, but the proceeds of life insurance policies do not have to be part of the losses. Use trusts and other tax-free options, name beneficiaries carefully, and do not hesitate to purchase another term policy each time new life events present themselves. If you have a $1 million life insurance policy and do not set it up as a trust, your survivors could pay as much as half of the settlement in estate taxes. The solutions are to either protect the money, or increase the size of the policy to include the tax requirements.