Do you need life insurance in retirement?

Life insurance is often seen as a way to replace lost income if a parent or spouse passes away unexpectedly. However, it can also be a strategic tool for estate planning. With the right life insurance policy, you can help protect your estate from unnecessary complications and prevent the forced sale of assets. Here’s a look at how life insurance can serve as both a financial safety net and an estate-planning tool.

Term Life vs. Permanent Life Insurance

When it comes to life insurance, there are two primary types to choose from:

• Term Life Insurance: This type offers coverage for a specified period, usually ranging from 10 to 30 years. It’s best for individuals with temporary needs, such as protecting minor children until they become financially independent. Term policies are typically more affordable due to their limited duration, making them ideal for young, healthy individuals.
• Permanent Life Insurance: Permanent life insurance offers lifelong coverage, which makes it more suitable for estate planning. However, it comes at a significantly higher expense. Within permanent life insurance, there are two common options:
  • Whole Life Insurance: Provides fixed premiums and guarantees a death benefit, unless you withdraw or borrow from the policy.
  • Universal Life Insurance: Offers more flexible premiums and death benefits, allowing for adjustments based on your needs.

Typically, permanent life insurance is most appropriate for individuals with large or complex estates that require long-term financial planning.

Why Choose Permanent Life Insurance?

For those seeking comprehensive protection for their loved ones, permanent life insurance can provide critical benefits. Here’s how:

1. Cover Estate Taxes

Estates valued over $13.99 million ($27.98 million for married couples) in 2025 are subject to federal estate taxes, which can be as high as 40%. Since estate taxes are due within nine months of the estate owner’s death, this can pose a problem if the estate is made up of non-liquid assets. For heirs inheriting assets like real estate or family businesses, life insurance proceeds can help cover these taxes, reducing the risk of a quick fire sale.

Even if your estate is not large enough to face current tax liabilities, tax laws change over time. The current estate tax exemption is set to expire at the end of 2025 if Congress does not extend it.

2. Tough to Divide Assets

Family businesses, collectibles, and real estate, can be difficult to split equally, especially if your loved ones disagree on whether to sell or keep the asset. Life insurance can help reduce friction with hard to split assets, ensuring fairness in the distribution of your estate.

3. Support an Heir with Disabilities

Providing long term financial security for a loved one with a disability can present unique challenges for an estate. The costs associated with lifelong care may drain the nest egg for other heirs. Life insurance offers a solution by allocating funds specifically for the care of a dependent with disabilities. This strategy may impact government aid programs, so careful planning in advance is suggested.

Maximizing Life Insurance for Estate Planning

While a life insurance policy can increase the value of your estate, it can also impact estate taxes. To avoid this, name an irrevocable trust as the beneficiary of your life insurance policy. When structured this way, the life insurance proceeds are generally excluded from your estate, which helps reduce estate taxes and provide your heirs with the liquidity needed to cover expenses.

Two common irrevocable trust types funded by life insurance include:

• Irrevocable Life Insurance Trust (ILIT): Policyholder transfers ownership of an existing life insurance policy to the trust or has the trust purchase a new policy. Since the ILIT owns the policy, the death benefit proceeds are excluded from the policyholder’s estate. The trustee can use the funds to pay estate taxes and fees or to distribute the proceeds to heirs according to the terms of the trust.
• Special Needs Trust (SNT): For an heir with a disability, direct inheritance could jeopardize their eligibility for government aid. The trust can ensure that the inheritance is used exclusively for qualified expenses, like medical care and education, without affecting eligibility for benefits.

Tax Considerations with Life Insurance

For most life insurance policies, the death benefit paid to your beneficiaries is not subject to income tax, if it pays out as a lump sum. However, if the benefit is paid out over time in installments, any interest earned on the payments will be taxed as ordinary income.

While your heirs benefit from tax-free death benefits, there are also some tax benefits for the policy owner. If you have permanent life insurance, the cash value that accumulates over time is not taxed as income. Additionally, you can borrow or withdraw funds from the policy’s cash value without incurring taxes, as long as the amount withdrawn doesn’t exceed what you’ve paid in premiums.