Life Insurance - An Estate Tax Solution

If you're like most individuals, you probably want to ensure your assets pass to your heirs in full at the time of your death. However, if you have a large estate, one of the greatest financial challenges potentially facing your heirs may be the payment of estate taxes. Have you given much consideration to how your estate taxes will be paid?

Generally, there are three methods that can be used to raise money to pay estate taxes: sell assets, take out a loan, or use life insurance. Here's a closer look at each option.

1. Selling Assets
   Some liquid assets (e.g., bank accounts, publicly traded stocks, and bonds) may be used to pay the estate tax. However, sale of these assets generally reduces the size of the estate by the size of the estate tax, dollar for dollar.
   
   Sometimes the tax may be too large for payment using only liquid assets. In these cases, houses, real estate, rental property, collectibles, and other illiquid assets may have to be sold to pay the tax. Assets, including undervalued, publicly traded securities, sold quickly during a forced sale or at an auction, usually sell well below potential fair market values. Consequently, your beneficiaries may potentially receive an even smaller inheritance than you may have initially planned. Thus, selling assets may not be the most appealing choice.
2. Borrowing the Money
   Quite often, an executor may be forced to borrow from a lending institution in order to avoid the forced liquidation of assets. The repayment of a loan with interest from assets of the estate will likely result in beneficiaries also receiving a smaller inheritance.
   
   If you own a closely held business, estate taxes may be paid on an installment method with low rates from the government - but, it's still a loan.
3. Discounted Dollars
   Individuals often arrange for life insurance to pay estate taxes. Theoretically, each annualized premium may be only a small fraction of the potential death benefit proceeds. Therefore, it's often described as using "discounted dollars" to pay the taxes because it is anticipated the life insurance policy proceeds will be greater than the total premium outlay over the life of the policy. In addition, policy ownership can be arranged so the policy proceeds will not be included in the insured's estate.