Why Get Life Insurance If You’re Financially Independent

I'm often asked why get life insurance if you're financially independent. It's a good question that merits a deep dive. I became financially independent in 2012 and have life insurance because I had children in 2017 and 2019.

Many of you will face the same dilemma once your passive income can cover all your living expenses or once your net worth reaches 20X your gross income. After all, you're one of the few who care enough about your finances to read this site!

But I'm a little surprised why the folks asking couldn't think of the many reasons why life insurance might be necessary after reaching FIRE. I guess if you haven't reached FIRE, don't have a family, or have never sat down with an estate planning lawyer, it's hard to know.

Here are some reasons why life insurance is a good idea despite being able to self insure. You can also click on the audio version of this post if you scroll to the bottom.

Benefits Of Life Insurance If You're Financially Independent

Here are seven key reasons why you should get life insurance after reaching financial independence or keep an existing policy.

1) You believe you'll die before the term limit is up.

Despite all the blood work and physical exams, insurance companies can only come up with a best case guesstimate of when you will likely die.

But despite all the actuarial data, you should know your health better than anybody.

If you think you've got a greater chance of dying before the term limit is up, then life insurance becomes a better deal.

Related: Term Life Insurance: The Best Choice For Most People

2) You want to provide liquidity. 

You may leave behind stocks, bonds, real estate, fine art, and collectibles, but they require an extra step to become liquid. Further, don't assume that all your assets will neatly go to your heirs as your will directs.

Probate court can tie up your assets for months or maybe years. Life insurance is a way to diversify giving.

Even if you have a trust and can avoid probate, illiquid assets take time to sell. You may also not want your heirs to sell certain assets.

On the other hand, life insurance payouts can be available to your beneficiaries in as quick as seven days. However, the typical payout is 30 days, which is still much faster than illiquid assets can usually be sold.

3) You plan on setting up a life insurance trust. 

A life insurance trust is an irrevocable, non-amendable trust which is both the owner and beneficiary of one or more life insurance policies.

If you set up a life insurance trust, it doesn't count towards the $11.58M per person estate tax limit, provided it has stood alone for a number of years. There is a limit to how much isn't taxable, but you'll have to check with an estate planning lawyer.

Here's a cool graphic on how a life insurance trust works. You create the life insurance trust as the Grantor and the life insurance policy proceeds are passed onto your beneficiaries. This structure allows the proceeds to pass on without estate tax.

Life Insurance Trust

4) The premiums paid are worth the peace of mind.

If you're financially independent, the monthly premiums aren't as big of a deal as they would be for someone who isn't financially independent. 

Therefore, it's easier to get life insurance if you're financially independent because you can afford it. And in turn provide greater security for your family.

It's the same logic as comparing people who can pay cash for a home but take on a mortgage because the interest rate is so low, compared to the person with poor credit who needs to take out a loan and has to pay a much higher rate.

Related: How To Get More Life Insurance For Less Money

5) You still have a large amount of debt.

You might have a massive net worth, but if you also have a large amount of debt, your net worth can disappear quickly during a downturn.

The time to sell anything is during a bull market, not a bear market. Think about how many wealthy people had to declare bankruptcy in the last recession due to being over-leveraged.

Further, if you want your heirs to hold onto the assets you leave behind for sentimental reasons or because you believe they are a good investment, life insurance can help.

Related: Life Insurance Needs For Young Adults

6) You have or plan to have dependents.

If you achieve financial independence at a young age, fantastic! You may have dependents already or plan to in the coming years.

When you have people depending on you or want to start a family soon or in the not too distant future, it's a good idea to shop around for life insurance rates.

Life insurance premiums rise as you age, and can spike dramatically if you develop a health condition later. Use your youth and good health to save money while you can and protect your family.

I wish I bought more life insurance before I had kids when I was younger and had fewer items on my health records.

Related: The Right Amount Of Life Insurance To Protect Your Family

7) Your estate's value is above the taxation limit.

Given you've got to pay ~40% tax on every dollar above the $11.7M estate tax limit per person ($23.4M per couple), your heirs might have a large tax bill if you are far beyond the limit. Hopefully, the estate tax threshold amount will continue to go up. However, I wouldn't bank on it with President Biden.

A life insurance policy can help your beneficiaries pay for any tax liability from your estate. High property taxes and ongoing maintenance costs are the reasons why many historically mansions are gifted to the state. Their heirs simply couldn't afford to take care of them.

Life Insurance Is A Good Deal

At some point, you truly may be sufficiently wealthy to not need life insurance. Maybe that net worth is over $10+ million per person, the ideal net worth amount for retirement. Ultimately, it's an individual decision.

But for the vast majority of us with dependents, having life insurance is a good idea. You can always reduce your coverage amount or cancel your policy as your wealth grows. That's what I plan to do.

I like knowing that my wife and kids will get an extra million dollars in case I'm stuck in a ravine somewhere with my car on fire. And I like that life insurance will pay for a good portion of my estate taxes if the estate tax limit gets lowered back down in the future.

It also makes me happy knowing that my kids will never starve, even if my wife ends up spending everything or getting bilked out of everything I leave her through a revocable living trust.

Related: The Best Age To Get Life Insurance Based On Logic

Financial Independence And Life Insurance

Life insurance is relatively cheap for people on the healthier end of the spectrum. You do not want to wait until you have some type of illness before getting a quote. Just having something as common as sleep apnea can cause your premiums to quadruple.

If you're middle class, then life insurance is even more valuable to your dependents than if you are rich. And if you're wealthy, the cost of the premiums are such a small percentage of your income that it makes life insurance also worthwhile.

Providing peace of mind to your loved ones is a major reason why people buy life insurance. It's a universal factor for people of all income levels, even those who are FIRE

Get Free Life Insurance Quotes Instantly

If you want to get free quotes from top insurers for a new life insurance policy today, check out PolicyGenius. You can check rates online with just a few clicks. And you can also talk to one of their life insurance reps to get personalized help for free.

Working with only highly rated life insurance companies, PolicyGenius shops multiple plans to help you deliver peace of mind to your family. Get a free quote today.

During the pandemic, my wife was about to double her life insurance amount for less money with PolicyGenius. We now have the same amount of life insurance coverage, which makes perfect sense since we are equal partners in raising our children and managing our finances.

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42 thoughts on “Why Get Life Insurance If You’re Financially Independent”

  1. It’s also valuable for those early FI whose assets are mostly in taxable, non-creditor protected accounts (i.e. not 401k/tIRA/rIRA).

    In those cases, if one manages to injure or kill someone while dying (e.g auto accident) the injured or their estate can easily pursue those assets the deceased planned on leaving to their heirs.

    But they can’t attach proceeds from a life insurance policy payable to named beneficiaries other than the estate.

  2. I am not financially independent, but have purchased multiple life insurance policies to temporarily park cash and build wealth. Also included in my portfolio, is your run-of-the-mill savings account, taxable brokerage account, tax-advantaged retirement accounts et al that would be incredibly stupid of me to not invest in or take advantage of.

    Life insurance isn’t the ultimate investment, but can be a very versatile financing vehicle (see example of how I leverage my policies mymattressmoney.com/simple-interest-loan-funding-compound-returns/). The death benefit, right now, is worthless to me, which is why I under-fund it for additional cash value that can be utilized today.

    Everyone’s situation is different and financial plans will be tailored to fit those needs, but I would argue the benefits of life insurance far outweigh the cons and therefore should be apart of everyone’s portfolio.

  3. In general I’m against the idea of life insurance after reaching a certain level of financial independence, simply because it’s a negative expected value (positive for the insurance company). If I don’t need it, then why take the loss on average in order to reduce a risk that isn’t that meaningful or substantial.

    If it’s a matter of your family members receiving enough money to cover their expenses and live a comfortable, financially stress-free life, then sure. But once that point is surpassed, I personally wouldn’t choose to buy a negative NPV asset just so my heirs are guaranteed $5m instead of $4m.

  4. Tax Free Retirement Expert

    Life insurance is best IRS-approved retirement savings plan available today. Niche insurance products allow you to pay taxes on “the seed not the harvest”, which is very important because as time passes the likely hood of taxes increases is very likely. These types of policies are ideal for healthy individuals as it reduces their cost of insurance within the policy meaning more money to your cash value component.

    There are two tax systems in America today! One for the Informed (lower taxes) and one for the Under-Informed (higher taxes). Qualified Plans (401k’s, IRAs, 403b’s ) are for the Under-Informed…

    Very few people know of these products, but they have been around for the last 30 plus years. I work with numerous financially independent people and these types of policies aid in minimizing their tax burdens and ensure tax free distribution of wealth to their beneficiaries upon death. Also we can grow this money in an life investment that intern locks in your principle and interest (protection against stock market downturns). In addition, these types of life plans can protect your money from creditors/predators (state specific). Life Insurance has changed dramatically over the years and the majority of folks are unaware of all the benefits that a custom policy can provide you and your family. I have listed some bullet points that should be very helpful.

    Life Insurance coverage with living benefits (i.e. access to cash within the policy in the event of heart attack, stroke, cancer, etc.)
    A pre-retiree can actually retire Tax Free
    Unlike traditional “qualified money investments” this type of account does not tax your social security check
    A pre-retiree can get the upside of the stock market without the downside risk
    Most pre-retirees want to keep a portion of their money safe from market risk and safe from Uncle Sam
    Their is no other Investment option that can grow tax deferred, be taken out take free, and be passed on to beneficiaries tax free.
    This type of account is like a ROTH IRA on steroids.
    No Contribution limits and no 59 1/2 or 70 1/2 rule to comply with
    LTC (long-term care)

    I specialize in educating folks on what is available to them so feel free visit us online or email me.

    Hope this provided some insight for those unsure about the power of life insurance.

    1. If the “Underinformed” are overtaxed, that would contradict what you say earlier when you were pitching whatever questionable insurance thing you’re selling by comparing it to a “ROTH IRA on steroids.” A ROTH, of course, is only for the underinformed. So which is it?

      Sam, this pitch makes me feel that bot posts telling me I can earn $ eleventy bazillion from home are coming next. I hope not.

      1. Tax Free Retirement Expert

        It behove you to do your research on the power of FIUL policies so you can make an informed decision.

        Roth IRA’s are great but they have age $ contribution restrictions. It comes down to flexibility and priories, needs, and budget of the client.

        For people looking to put more money away and yield a far better return and also get the benefits listed above an FIUL is the way to go (again you must qualify health wise), so its not the right fit for everyone.

    2. RetiredAt53

      Ge whiz Wally, how can I be smart too?

      The reply is about Equity Indexed Life Insurance. You can get a free steak dinner if you sign up to listen to some of these pitches. The theory of these products is great. No loss indexing of the market, more on that later. The execution is where I have the issues. The commission is huge, at least the one I could get to provide real numbers. Example I was provided was open account with 100k Jan 1 in the account, 5% return for the year account value on Dec 31…. 80k.

      Big penalties if ya pull out early.
      When you ask for money back it is in the form of a loan against the policy. Think about that. At 70 you take a loan out for 100k on your policy. Loans have interest that accrues and decreases policy cash available, every year more interest that may or may not be offset by returns on remaining cash value.

      If ya smoke, have heart problems, diabetes, etc cost of the insurance component is too high to make it worthwhile.

      So, be smart, invest in real estate, lots of tax benefits there also.

      If ya want to “no loss” index the market without the risk, toss money in a bond, cd and use a small portion to purchase options on the s&p 500. You can get a Sept 2018 market priced option for about 4% of the value of the underlying. Long term cd pays 2.5% so your loss will be 1.5%, sorry, not no loss, regardless of market down. You get majority of upside, no dividends, obviously. If ya toss the options in a Roth, no tax either. If ya want no loss, only use the amount of cash generated by the cd to purchase the option, this will lower the “Participation rate”. Market loss would result in options worth zero, but interest from CD covering that.

      If ya have faith in the us gov, savings bonds, if kept for 20 years will pay 4%. No access to the interest and cash for a few years.

      Not a fan of EIUL, sorry not sorry.

      1. Tax Free Retirement Expert

        A lot of your issues can be easily addressed by designing the policy correctly, and yes unfortunately there are people that sell these products that do not design the case to yield their clients the best return but rather front load the policy so they increase their commission. The top FIUL products historically have yielded a 7.02% (real rate of return) over the last 20 years, so they out perform cds and bonds.

        Many of my clients use these policies to fund their real estate ventures as it allows them to leverage their money in multiple places. These policies are very effective for the financially independent because essentially we are teaching people how to be their own bank.

        It is very important to do your due diligence and work with a financial planner who is an expert in the field.

        1. Interesting. Every EIUL guy I know and purchased a steak for me says the same thing. It has to be designed properly, but when it comes down to the design there’s always a large commission that needs to be overcome. If I start at 100K and you start at 80K, who wins the race besides the dude that gets the 20K commission?

          A 20 year 7% return for a product that claims no downside and market indexed seems kinda low. Sure it beats bonds and CDs but who’s talkin’ about that?

          Perhaps the Savings Bond comment was not explained enough. To do synthetic indexing (options on S&P, DIA, QQQQ) you need to put the cash somewhere that has a (mostly) guaranteed return. The real returns come from the options NOT the CD/Bond.

          You start with 80K and I’ll toss 95K into a CD/Bond making 2.5% moving small amounts 10K/year/person to savings bonds for 4% for 20 years. I’ll take the remaining 5K contribute the max-ish to a roth and purchase control of about 100K worth of S&P options until September (sorry no 2018 October/November yet on Yahoo). Todays price 5K would buy 111K equivalent (Sept18 258s are $11.53). You can use less to reduce the max loss. Years that the options go bust, the next year you have another roth contribution that you can use to start all over. Over time that’s a bunch of control of large sums. So, if you take a maximum 1% (over time using the 4% bonds) loss and invest in the S&P for 20 years, during that 2001, 2008 time you lost 1% ya think you could beat 7%, I do.

          With the EIUL you can fully fund or fund over some period. Don’t miss a year. EIUL is controlled by the insurance company. The contract wording is in their favor. The folks that can afford to put larger amounts into this are older and generally have higher insurance costs. The amount of policy is also limited on the “value” of the insured. Because I’m old and diabetic, I asked about using my son as the insured, the insurance and cash value amounts were small because at this point in time, as a college student apparently he is not worth as much as his old man. Personally, I think he is worth more.

          The suggested synthetic indexing alternative is completely under the individuals control. When he needs money, no loans, no interest payback on the loan, no age limits because ya did not toss large sums into retirement accounts, just enough to synthetically index and reduce risk. The majority is still under your control in a CD/Bond/Fixed income.

          I agree, everyone needs to be informed and seeking advice is needed. With that, let’s get informed:
          Let’s say I’m a healthy 55 year old male. No cancer, non-smoker, but as with many folks I have a parent that had a heart attack. I make $250K a year and have a net worth of $1.5M, great credit (non of these are real) Provide some numbers:
          How much insurance is possible?
          What’s the cost?
          For how many years?
          How much does it cost to “borrow” my money back?
          When can I take my first “loan”? Approximately how much with a 7% avg return?
          In a market loss year how much loss due to expenses and insurance cost will I incur? Use a table if not constant.
          Put it all out there, show how great it is and gain some clients!

          I guess we need to start talking about infinite banking next? Alas, “Oh Brave new world with such creatures in it. Tis new to thee” – paraphrased

          Again, sorry not sorry.

          1. Tax Free Retirement Expert

            The 7.02% is a real rate of return not an average rate which is the key. That means there is never a negative because you do not participate in the downside of the market.

            DoneAt53 – I would be glad to take a look at your situation. Again the FIUL is usually only a piece of the picture when it comes to the financial planning that I do with my clients. I am a numbers guy and focus on educating my clientele about the benefits and negatives of anything that I propose, so feel free to email me @ kwagner@peakfinancialcorporation.com and I we can further discuss and see what strategies might be ideal for your financial situation.

  5. FinancialTrailblazer

    As a few have mentioned that it may not make sense to purchase life insurance once one is financially independent, I would respond by simply saying that is dependent upon several key assumptions. First, the assumption that the markets will continue to go up and go up in such a way that they are somewhat comparable of the last several decades. Even if we are talking the past 100 years, the greater cycle is not always considered. I am not saying the markets will be stagnant or even that they won’t do as well as they past — no one knows. But what I am saying is that there is a real possibility that many of the factors of the century that have become assumptions, are certainly not guarantees.

    In simplest terms, it never makes sense to put all your eggs in one basket. A reasonable term insurance policy could help you avoid doing just that. If something were to happen to you in the next decade and the markets experienced another “lost decade”, and your wife or children needed that money within the trust, your family could very well be in a much worse position than if you had a cheap term policy that could have covered them immediately.

    You must always be aware of the assumptions you are making. Having a better understanding of the true economic environment and the consequences of competing factors will always help you make better decisions. By assuming the markets will always go up over any significant period of time is simply a bet, and one that history does not support. Again, not saying they won’t, but when it comes to providing for your family in the event of an unforeseen situation (such as why you purchase insurance anyway), you should not leave that portion of your financial picture up to a bet.

  6. Though you make some solid points, I just don’t see the need for life insurance at this point. If something happened to my husband, then I would go back to work. I’m fine with that because I would want to work to get over the loss and grief. Right now, I focus on protecting my assets with umbrella insurance and other types of preventative services.

  7. A few years ago I purchased additional life insurance on top of the 2x the salary I get at work. I was still healthy and a 20 year term policy was very affordable. Life insurance policy at work terminates with your employment and I didn’t feel comfortable enough with just that. My kids were teenagers at the time and if something was to happen to me they would require some cash quickly to keep up with all expenses. All my assets including investments could be tied up for a while between bank, lawyers and the government if something happens to me. With life insurance, no matter what the amount is, it will go straight to them, no tax. Once my kids are on their own, I plan to cancel the policy. I don’t see the benefit of paying life insurance premiums if nobody is relying on that money to live on.

  8. I don’t get when people buy term life insurance yearly through work. Yes, it may be a little cheaper, but it’s gone if you leave or get let go at which time you may have health issues. Free 1-2x salary, of course you take it, but above that, get term insurance for x years you know will be around.

    1. We get life insurance and medical aid through work and I recently I convinced a friend of mine to cancel his outside life insurance because it was a waste of his money. I pointed out he should be spending/saving it on himself because our situation is different.

      We’re single, no debts, no significant others or kids, just our elderly parents. If anything were to happen to us, the work insurance is enough to see them through to the end of their lives. If we’re fired or leave, we can then take up an outside policy if we feel our financial undertakings won’t cut it.

      I think we may be the one exception to the insurance rule.

  9. At work, I am able to buy 2x my annual salary for $1 per year. My wife and I also have a $500k policy. Mine costs around $25 per month and her plan costs around $41 per month because of heart disease in her family. They are cheap and provide some peace of mind in case one of us passed away.

  10. At 55 years old, insulin dependant diabetic but in good health otherwise, even the EIUL sales folks don’t like to talk to me!

    We’re FIRE, a little under estate tax limits and just do not see the need for life insurance.

  11. Many years ago, I purchased a 20 year term policy for 1 million. It was cheap at the time when I was young and healthy. Several years in, I upped it to 2 million because we live in HCOL area. I’m more than half way through the term and it’s given me peace of mind. In the future it will probably be too expensive to renew so I’ll probably let it run out. In the meantime, increasing my umbrella insurance for asset protection.

  12. Great conclusion! You’re paying for the peace of mind and #6 should take care of all that doubt for the price you’re getting. If you’re already financially independent, it doesn’t hurt to protect what you have with a little cost that you won’t miss. It’s not like life insurance is horrifically expensive or require a hefty one time payment. The peace of mind is worth it.

  13. Doesn’t make any sense to me in retirement. The whole point of financial independence is to not be stressed about money and to be happy with what you have. You don’t need the payout upon death, and the monthly fees you are paying are only delaying your retirement, potentially by a few years. If you are worrying about life insurance, you haven’t reached financial independence.

    You mention peace of mind, but FI is already peace of mind, that’s the whole purpose of it.

  14. “…once your net worth reaches 20X your gross income.”

    Isn’t the more important metric 20x your annual budget – especially if you’re living on <<50% gross income with the goal of retiring early?

    1. 20X your annual budget is an easier way out. You can one day slash your budget by 80% and then try to retire early. But life has a way of surprising you with expenses. So if you take the average 3 years of your gross annual salary, and never spend more than you make, you will be set and never have to worry. I don’t want FS readers to have to drastically cut back their lifestyles in retirement.

      Related: Net Worth Targets By Age, Income, And Work Experience

  15. Hi Sam,

    I just recently cancelled my policy. It was a 20 year term with 4 million in coverage which cost me 7k per year. Yes I’m a tobacco user. I was required to have it until I paid off my business which I did last year.

    My goal is to keep mine and my wife’s net worth at the top estate tax exclusion rate and than spend everything above and beyond that limit each year. If the estate tax is excluded or the limits raised than I’ll go for broke.

    As a couple you can accumulate 11 million before estate taxes kick in. I figure that should be enough. If it’s not, than I did a pretty poor job raising my kid.

    Thanks, Bill

  16. Hi Sam – great post and solid reasons. Add small business owners to the criteria for #4 – one of the reasons small businesses can have trouble lasting multiple generations is the liquidity crunch / tax due when the owner passes.

    There’s also a significant asymmetry with life insurance – having too much is not that big of a deal (and term for a healthy person just isn’t that expensive), but having too little is a really poor legacy to leave. I’m halfway through a 20 year term, and I probably don’t need it anymore, but the last ten years are way cheaper than I can get in the market today, so I’m happy to maintain it.

  17. We’ve been discussing life insurance with our estate attorney with our son as the beneficiary. We’re 51 years old and FIREd about 18 months ago. Good list of reasons!

  18. My big thing for right now is I want to make sure that if either my wife or I die, the other can pay off the house and be comfortable afterward should we choose. I think ultimately if that were to happen the surviving spouse would sell the house, but I’d much rather have the OPTION to sell it than feel forced to because it would be otherwise impossible to pay the mortgage and pursue our passions in life.

    Even once the house is paid off you raise some compelling reasons to keep life insurance. Like Ms FAF, we have life insurance provided through work as well, but I view that as icing on the cake. After all, jobs change, and it’s not nearly enough to feel 100% comfortable.

  19. 100% aligned.

    $1,200 a year for a million bucks in term.

    It’s such a no brainer that the usual FIRE community debate on this is so odd to me.

    1. I just don’t get it. If you have enough assets to support your family if you die, how does having an insurance policy improve things other than giving them even more money. I don’t see the point of buying a policy you will likely outlive to give your heirs more money than they need.

      1. Many people get life insurance before they are financially independent. And once they’ve reached a level they deem financially independent, they simply keep it as a bonus financial instrument for diversification purposes. The premiums, like a fixed mortgage, are the same, but since your income/wealth is much greater, 10, 15, 20 years later, it’s an insignificant cost that provides added benefit.

        Where are you in your financial journey? Do you have dependents? Thx

        Similar Analogy: The Vacation Property Rule To Follow

        1. Ok that makes sense if you already have had a policy for many years. The premium is pretty low most likely if you got the policy when you were young so might as well keep it. I am very early in my financial journey. About 40k in retirement savings at age 30 and basically no other assets. Not in a high paying career so only have that much because I lived with my parents for a long time and could save more. I have no dependents. Don’t plan on getting life insurance myself unless I make significantly more money and wouldn’t have to cut back on other things. I figure my husband can fend for himself if I die.

  20. I just can’t get on board with life insurance after financial independence. There are better ways to pass assets to your loved ones after you have them. Things like trusts, gifting early, etc come to mind. All have a better return and are less permanent in case you need funds. In my mind a life insurance fund is for ensuring your loved ones have enough at your death to keep going, not to create a legacy. That means until FI I believe everyone should have it. But once I hit my number I fully intend to cancel ours. Even today’s ours is a low amount, just enough to get my wife to a relatively stable situation 5-10 years. It may or may not make her FI, but in my wife’s case it wouldn’t matter. She has her own career and that doesn’t stop if I’m gone.

    1. Agree. Trying to understand why others think its a “no-brainer” and it doesn’t add up for me.

    2. I am FI and over the estate tax exemption and I still bought life insurance. My estate lawyer says I shouldn’t have.

  21. Mr. FAF and I have our life insurance through our employers. It’s 2-3X our annual salaries.

    We don’t really think much about it, but we are appreciative that we can get it without having to pay for it. Once we are FI, I think we might have to revisit this topic. :)

  22. Brad - MaximizeYourMoney.com

    I’m not sure I understand the points on taxes. Generally life insurance is paid out without a tax liability. So getting insurance up to the exclusion limit doesn’t make sense to me. That really shouldn’t even be a factor.

    Why *I* still have life insurance even though I’ve achieved FIRE: Because I already had a policy in place and it’s cheap.With 8 years left on our term, that will cost about $6500 through the end of the term. But if I die it will pay out $750k.

    Like I said – pretty cheap.

    And that money can always be used for something good. If not needed (and it shouldn’t be) it can be passed on to heirs, or donated, or used for some other good cause.

    1. It’s easy to understand. Some people plan to accumulate more than the exclusion limit in their lifetimes. So life insurance is a estate planning strategy where they can estimate the difference between the current limit and their current net worth, get that much, and then gradually reduce the amount until they reach the limit or go over if they wish.

      It’s easier to reduce the amount of life insurance as opposed to increase the amount as you get older.

      And once you go over the limit, as Sam explains, life insurance can be used to pay for estate taxes.

      The key to understanding anything is to put yourself in someone else’s shoes, and not just think about your own situation.

      1. Brad - MaximizeYourMoney.com

        Apparently it’s not “easy to understand” because it still doesn’t sit right with me.

        Since life insurance is generally tax-free, I don’t see how the exclusion limit comes into play.

        If someone has a $3m net worth but wants to leave $5.5m to their heirs, then sure, get a $2.5m policy. That’s independent of any tax limits though because the insurance isn’t taxed.

        And no, I’m not looking at this from just MY perspective. I’m looking at it from a general financial advice perspective.

        I’m a fan of life insurance; term specifically. Just trying to either understand – or clarify – how the estate tax limit would impact someone’s decision.

        BTW, I’m a fan of Sam and this blog also. I just feel like point #1 might need clarification.

        1. To my knowledge you are correct as long as the life insurance policy names a specific beneficiary (a person) and not the estate as the beneficiary. If the estate is named as the beneficiary then the life insurance proceeds will be included in the total estate value.

          So, if you have an estate valued at $5.5 million and a life insurance policy valued at $2.5 million all of that money could be received tax free as long as a beneficiary is named on the life insurance policy and not the estate. The $5.5 million would fall below the limit and the $2.5 million would not be part of the estate since it would be distributed directly to the beneficiary.

          1. I don’t think that is quite correct. I just did some research and it looks like if you are the owner of the insurance policy then it is included in your taxable estate. In order to not be the owner of the policy you have to transfer ownership to someone else at least 3 years before your death or the IRS will consider the proceeds part of your estate. Also if the life insurance policy has any cash value at the time you transfer ownership it will be subject to gift tax. The new owner has to pay all premiums on the policy and you cannot retain any rights over the policy such as to name beneficiaries.

            1. I’m not sure I follow what you are saying. Generally any cash value in a whole life insurance policy is surrendered at the time of death and only the face amount of the policy is paid out to the estate or to whoever is named as the beneficiary of the policy.

              If “John” had a $2.5 million life insurance policy (whether term or whole life) and died, the face value of the policy ($2.5 million) would be paid out to either (1) his estate or (2) named beneficiaries. If it was paid out to his estate it would be included in his taxable limits before being distributed. If a beneficiary was named, the face value of the policy ($2.5 million) would pass to that beneficiary immediately and would not be included in “John’s” total estate for tax purposes.

              I’m pretty confident this is correct – my wife is an accountant and confirms. However, I would love to hear from someone in the Financial Samurai community that is an expert on taxes/estate planning!

          2. No I looked it up in the Internal Revenue Code. Section 2042 says that life insurance payable to beneficiaries other than the decedent’s estate are part of the decedent’s taxable estate if the decedent had any incidents of ownership in the policy. If you are the owner of the policy and paying the premiums you have incidents of ownership and it would be included in your taxable estate. My comment about the gift tax was about transfer of ownership before your death. You can transfer the policy ownership to someone else but if it has cash value you could owe gift tax. The new owner also has to pay the premiums so it can get a bit complicated to pass ownership unless you have a trusted relative willing to take on the task or you set up a trust and appoint a trust company as the trustee.

            1. You both are kinda correct. The best way is to set up trust and place the Insurance there. Making the trust irrevocable is the key. Great thoughts.

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