Life insurance can offer financial security for your loved ones. It provides a tax-free lump-sum payment upon the insured's death. About half of Americans have a life insurance policy, mainly to cover burial and final expenses. But it can do more—like replacing income, paying debts, funding trusts, or equalizing inheritances.

However, life insurance doesn't pay out in every scenario. It's crucial to know the conditions that can nullify your policy. Let's explore how life insurance works and why it's essential to use it wisely in your estate plan.

How Life Insurance Works

Life insurance involves these key players:

• Policyholder: The person who owns the policy and pays the premiums.
• Insured: The person whose life is covered by the policy.
• Beneficiary: The person or entity receiving the death benefit.

The policyholder and the insured can be the same person. The insurer agrees to pay the death benefit to beneficiaries in exchange for regular premium payments.

Types of Life Insurance Policies

There are three main types of life insurance:

1. Term Life Insurance: Covers a specific period. The death benefit only pays if the insured dies during this term.
2. Permanent Life Insurance: Offers lifetime coverage and builds cash value over time. Includes whole life and universal life.
3. Employer-Provided Insurance: Offered and paid for by employers. The death benefit may require active employment at the time of death.

Payout Structures

Life insurance policies offer flexible payout options:

• Lump Sum: A single payment to the beneficiary.
• Installments: Payments spread over time.
• Life Annuity: Provides ongoing income to beneficiaries.

Some permanent policies allow policyholders to access cash value through loans or withdrawals during their lifetime.

Tax Implications

Most life insurance payouts are tax-free. However, there are exceptions:

• Installments: The principal is tax-free, but accrued interest is taxable.
• Estate Taxes: If the insured owns the policy and the estate value exceeds the federal exemption, it may trigger estate taxes.

Understanding tax implications ensures beneficiaries receive the intended benefits.

Designating Beneficiaries

Naming the right beneficiaries prevents unintended complications. Avoid these common issues:

• No beneficiaries are named.
• Beneficiaries predecease the insured.
• Minors or incapacitated adults are named.

When minors or incapacitated individuals inherit, courts may appoint someone to manage the funds. Setting up a trust can avoid this issue and ensure proper management.

Common Uses for Life Insurance

Life insurance proceeds are versatile. Beneficiaries can use the funds for any purpose, such as:

• Paying off debts: Covers mortgages, loans, or credit card balances.
• Funding trusts: Supports minors, special needs individuals, or surviving spouses.
• Equalizing inheritances: Balances distribution among heirs when dividing property is impractical.
• Ensuring business continuity: Funds buy-sell agreements or transitions.
• Covering taxes: Pays estate or income taxes without liquidating assets.

Why Life Insurance May Not Pay Out

Policies contain exclusions that can nullify payouts. Common exclusions include:

• Expired term policies: Coverage ends after the term unless renewed.
• Employment-dependent policies: Coverage stops when the insured leaves the job.
• Risky activities: Policies may exclude skydiving or similar high-risk activities.
• Illegal activities or substance abuse: Deaths from these causes are often excluded.
• Fraud: Misrepresenting facts on an application can void coverage.

Review your policy carefully to understand its exclusions and conditions.

Integrating Life Insurance into Estate Planning

Life insurance can secure your estate plan. Use it to:

• Fund trusts for specific needs.
• Pay estate and income taxes.
• Ensure liquidity for probate costs.
• Replace income for surviving family members.

A College Station estate planning attorney can help structure your plan to meet your goals. Call us today at 979-703-7014 to schedule a consultation to integrate life insurance effectively into your estate strategy.