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Tips From The Pros: The Biggest Lie in Life Insurance

Charles A. Redd explains why life insurance isn't always necessary

Life insurance can serve several valuable, sometimes critical, purposes. It can create liquidity in an estate comprised largely of illiquid assets the family intended or hoped to retain intact. Without life insurance proceeds, such an estate is often compelled to sell (sometimes quickly and at artificially low prices) such assets to raise money to pay debts, post-death administration expenses and estate taxes. Of course, in the current era of an historically high, and growing, basic exclusion amount,1 coupled with a relatively low rate2 and the unlimited estate tax marital deduction,3 the need for life insurance to provide cash with which to pay federal estate tax is greatly diminished as compared to what it once was.4

Additionally, life insurance can generate the cash with which to implement the requirements of a buy-sell agreement when the death of one closely held business owner triggers an obligation of the surviving owner or the company to purchase stock from the decedent’s estate. Life insurance can provide funds to be invested for the benefit of surviving members of a family whose breadwinner died before accumulating an estate sufficient to support the family. Life insurance may also serve to enhance investment diversification.

Desire vs. Need

The role of life insurance in an estate plan is distorted, however, when it becomes a solution looking for a problem. Take, for example, a case in which a married couple with three self-sufficient, responsible, adult children has a $20 million estate consisting of a comfortable but not palatial residence, some cash and cash equivalents and a well-diversified portfolio of readily marketable securities. Assuming the current federal estate tax regime isn’t repealed or materially changed5 and ignoring potential appreciation or depreciation and consumption, as well as indexed increases in the basic exclusion amount,6 that will occur before both spouses have died, about $3.6 million in federal estate tax will be due at the death of the surviving spouse.

In the above example, is life insurance “necessary”? The knee-jerk answer of some would be “yes” because there’s an expected $3.6 million estate tax liability that must be “covered.” This answer, however, is unquestionably wrong. Life insurance in this situation may legitimately be desired, but there’s clearly no need for it. Life insurance in this scenario simply serves the purpose of creating additional estate value by which to enhance the children’s inheritance.

Under the facts recited above, the spouses could reasonably conclude that a net, after-estate tax inheritance of $16.4 million for their children, to be divided equally among them, is quite adequate and appropriate. Alternatively, the spouses might aspire to leave their children an inheritance larger than $16.4 million and be willing to fund a second-to-die life insurance policy to achieve that goal. In the context of this latter objective, observe that the $3.6 million in projected estate tax has no significance whatsoever. The fundamental estate- planning issue that should be presented to clients with an estate-planning profile such as this isn’t the anticipated amount of estate tax to be paid at the survivor’s death but, rather, the net amount they wish to leave to their children. In the above example, that amount may be $16.4 million, $30 million or some other amount, but it’s illogical, and in fact arbitrary, to base a life insurance acquisition decision on what’s believed will be the amount of the eventual estate tax bill.

Informed Decisions

Thus, the biggest lie in life insurance is: You need life insurance to pay your estate tax. Even when the proposed insured expects to die with an estate large enough to require payment of estate tax, this often just isn’t true. Whether life insurance is necessary or even desirable depends on the composition of assets in the estate, the objectives of the client and the client’s legal obligations that are expected to survive him. In life insurance planning, as in all aspects of estate planning, it’s incumbent on advisors to provide their clients with objective and forthright analysis, along with full information about available alternatives and their consequences, so the clients can make informed decisions.  


1. Internal Revenue Code Section 2010(c)(3). The basic exclusion amount for 2017 is $5.49 million.

2. Effectively, a flat rate of 40 percent. IRC Section 2001(c).

3. IRC Section 2056(a). The marital deduction has been unlimited in amount, except with respect to transfers to non-U.S. citizen spouses, from and after Jan. 1, 1982.

4. As recently as 10 years ago, the “applicable exclusion amount” was $2 million. When this writer graduated from law school in 1979, the “unified credit exemption equivalent” was $147,000, and the maximum marginal rate was 70 percent.

5. The new administration and the Republican Congress have clearly signaled their intention to repeal the “death tax.” See Charles A. Redd, “A Turbulent Time of Twists and Turns,” Trusts & Estates (January 2017), at p. 12.

6. See IRC Section 2010(c)(3)(B).

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