How those in the LGBT community can use life insurance planning strategies
by Grace S. Yung
While the advantages of life insurance are many, this type of coverage may be especially important to the LGBT community, as the proceeds of these policies could help to compensate for shortfalls in other areas such as Social Security survivor or widows’ benefits.
Protecting a Partner and Children
There are three key areas where life insurance can be particularly important. First, life insurance policies that name a partner as the beneficiary can be ideal for helping to pay off large debts or provide ongoing living expenses of the surviving partner and/or children. This can also help to ensure that the surviving partner will not lose their home if he or she can’t make mortgage payments after losing the deceased partner’s income. This is especially helpful if these individuals had depended on the deceased partner’s income and would otherwise need to make drastic lifestyle changes.
Effectively Transferring Wealth
Next, life insurance proceeds may also be used to transfer wealth to a surviving partner. In many cases, assets of the deceased partner must go through probate—the process by which the state dictates who is to receive the assets. In the absence of a will, assets are typically awarded to an individual’s legally married spouse or other blood relatives. Because life insurance proceeds can bypass probate, making a partner the beneficiary of a life insurance policy can help to ensure that funds will go directly to the intended recipient.
In bypassing the probate process, direct receipt of life insurance proceeds can help lessen a partner’s stress during an already painful time. Plus, by directly receiving the funds from a life insurance policy, the proceeds are also not subject to creditors or even to the deceased partner’s relatives who may try to challenge a will and potentially cut out the surviving partner from receiving anything. This can help to ensure that a partner will not be left destitute due to a family dispute.
One of the best ways for LGBT individuals to transfer wealth is via an Irrevocable Life Insurance Trust, or ILIT. The key purpose of such trusts is to remove life insurance death benefits from the gross estate of the grantor for estate tax purposes. In the current tax law, this is not presently an issue for those with estates valued at under $5 million. However, in 2013 this exemption amount will drop, effectively taxing many more individuals.
Whereas legally married couples are allowed to pass an unlimited amount of assets to one another at death, this is not currently possible for unmarried partners. Although life insurance proceeds are free of income taxation, they can be included in the calculation of a partner’s total assets for estate tax purposes. In this case, because the proceeds from an individually owned life insurance policy would be included in the decedent’s gross estate—and is also includable in his or her taxable estate—placing the policy into an ILIT can remove this obstacle and allows the proceeds to be used to pay the estate taxes that are due.
It is important to note here that in some cases there is a three-year “look back” period when initiating this technique. This means that if the transferring party lives for less than three years after making the transfer, the proceeds will still be subject to estate taxes.
In other cases, if it is anticipated that the estate of the second partner to pass away will have a need for additional life insurance proceeds with which to pay their own estate taxes, a “second to die” or survivorship life insurance policy could also be purchased inside the ILIT. These types of policies actually have two insured parties, with the death benefit being paid out at the death of the second individual. Although this planning technique may not directly benefit either of the partners while they are alive, it can allow for the first of the partners to pass away an option for leaving other assets for their surviving partner with the knowledge that the insurance proceeds will still be available to pay the increased amount of estate tax that will be due at the second partner’s passing. This is important because domestic partners are not eligible to pass assets tax-free via the unlimited deduction available to legally married spouses.
Protecting Business Assets
The third important purpose of life insurance is to protect business assets, should one or both partners own or run a company. There are a number of ways that life insurance can be used by LGBT business owners. While many of the benefits address standard business situations (such as providing a financial cushion due to the loss of a key employee, or purchasing the deceased owner’s share of the business), constructing a policy that helps LGBT business owners plan ahead for their personal estates can be crucial.
Different strategies can be used depending on a specific LGBT couple’s situation and goals. In the case of a family business, for example, should the family of partner #1 want that individual’s share of the business to remain with them if partner #1 passes away, then life insurance proceeds could be used by that partner’s family in order to buy out partner #2’s share of the company.
This planning method can also work in the other direction. For instance, should an LGBT couple own a business and each partner would like the other to retain control of the business should the other pass away, the partners could employ a strategy using life insurance. In this instance, each of the partners would purchase a life insurance policy on the other. Then, if one of the partners passes away, the survivor could use the life insurance proceeds to purchase the deceased partner’s portion of the company.
Should there be more than two owners of a business, these individuals could utilize a cross-purchase strategy with each partner purchasing a life insurance policy on the life of all the other partners. Here, too, should one of these individuals pass away, proceeds from the policies on that person’s life can be used by the others to keep the business afloat until a replacement is found, or so the other partners can buy out the deceased partner’s share.
It is important that partners understand when it is best to have the company own the policy, rather than having the individual partners own it. In this case, partners should consult with a qualified professional to guide them.
Choosing the Right Type of Policy
There are many types of life insurance coverage available in the market today. Prior to moving forward with a policy purchase, several questions should be answered in terms of the purpose and goals for the coverage.
For example, partners may need to determine whether they should obtain a “first to die” policy or if two separate policies should instead be purchased. “First to die” life insurance is a type of policy where more than one life is insured, yet the policy will only pay out benefits at the first death. While this may save the partners some premium dollars, in most cases it may not be the best alternative. Building an efficient insurance plan is about more than just trying to save money. In the case of two partners, both will require funds for the purpose of paying final expenses.
Regularly Review Coverage
Even if individuals or couples already possess life insurance coverage, it is important to regularly review these plans and make updates if necessary. When circumstances change, such as the birth or adoption of a child or the purchase of a new home, life insurance coverage needs can also change.
There are also many instances where an existing policy can be improved using a “tax-free upgrade.” For example, it often makes sense to own permanent coverage, given its longevity as well as its savings component. Oftentimes it is possible to convert an existing term life insurance policy to a permanent plan without evidence of insurability.
In any case, all life insurance planning should be done through a qualified financial professional who has a proper life insurance background, as well as being well-versed in the life insurance needs of the LGBT community.
The Bottom Line
A well-constructed financial plan that includes the use of life insurance is crucial for those in the LGBT community—especially if they wish to keep more assets for a surviving partner and have less going to Uncle Sam. By directing how the proceeds of a life insurance policy are owned and distributed, domestic partners can exert a great deal more control over how their estate is ultimately managed.
Grace S. Yung, CFP, is a certified financial planner practitioner with over 18 years of experience in helping domestic partners to plan their finances. She is a principal at Midtown Financial LLC in Houston.