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How to Use Life Insurance to Save Money

saving money as a single person

 

UPDATED, February 26​ - Single people undoubtedly have experienced the sting of paying higher taxes.  Whether it is higher federal income taxes or higher federal and state estate taxes, the average single person will end up paying more in taxes than their married friends.  However, this burden can be lessened with careful estate planning and life insurance.

 

Local estate lawyers or financial experts can provide a wealth of information pertaining to a single person’s estate and how to pass on more of their estate to family and heirs.  Potential solutions include different ways to pay an estate tax bill.

Estate Growth Implications for a Single Person

When a person dies, their estate is left to their heirs.  However, before these assets are distributed, the federal and state government take out a portion for estate taxes.  This amount can quickly add up and must be paid in cash before any estate assets are passed on to heirs.  This can leave an estate administrator with the task of liquidating estate assets at a lower rate due to the time constraints placed on the estate.

 

A Closer Look at Estate Taxes

For many workers, retirement is seen as the finish line.  However, in reality, it is just the beginning.  Having enough money to last during a lengthy retirement can be problematic for those who are worried about having enough money to last for the additional 10, 20, or 30 years after retirement.  

In addition, estate shrinkage due to federal estate taxes can take up to 40% of an estates value after death, leaving less for estate heirs.  The size of an individual’s estate at death determines the estate taxes due.  For example, a single person age 65 with an estimated $2,000,000 estate today can expect to see a growth rate of 8% by the time death occurs in 20 years.  This gives the estate a total value of $9,321,914.  Even more can be realized if the growth rate is higher.

 

With an estate valued at over $9 million, administration costs of 5% can deplete this amount by almost half a million dollars.  In addition, federal estate taxes can take an additional $1,346,327 based on a 40% rate leaving the estate that originally was valued at over $9.3 million with almost $2 million less.

The Common Misconception of Federal-State Taxes

Many people believe that when federal estate taxes are payable, the federal government simply takes a portion of their estate to pay the estate taxes due.  However, what actually happens is even worse.

 

The federal estate tax is actually a transfer tax that is imposed on assets that are transferred after death.  The amount of this tax is not merely based on a set amount, but rather is measured by the value of the assets transferred from the estate to the heirs.  

The problem arises when the estate tax is levied and then payable to the federal government.  Since this amount can only be paid in cash within 9 months of the death of the estate owner, heirs are left with the problem of finding the cash needed to pay this amount.

Often, this difficult situation is remedied with a quick liquidation of assets.  However, when assets are liquidated quickly, the amount received for those assets can be pennies on the dollar.  This leaves even less assets for estate heirs.  Estate administrative costs must also be paid in cash as well.

 

Potential Solutions

There are four ways to provide estate heirs with the liquidity needed to meet the hefty federal and state estate taxes along with administrative costs.

 

  • 100% Method – A person could accumulate enough cash in the estate to pay the estate settlement costs directly.  However, this method means that there needs to be a large accumulation of cash left in a bank or other financial institution.  Many successful business people are successful due to their investments, not from leaving their money sitting in a bank.

  • 100% Plus Method – After death, the estate could borrow the cash needed to pay the estate settlement costs.  However, this is not the best method because the money that is borrowed not only decreases the overall estate value, but leaves heir paying back the borrowed amount with interest.

  • Forced Liquidation Method – The least advantageous method forces the estate to liquidate sufficient assets in order to pay estate settlement costs.  Forced liquidation usually only brings a small fraction of the true value of the estate’s assets if the market is not strong.  In addition to the lost value of the assets, the additional expense of sales is bound to be incurred.

  • Discount Method – For qualified estate owners, arrangements can be made now to pay the estate tax bill with life insurance.  The foreseen amount that will be needed to pay federal and state estate taxes along with administrative costs are calculated.  Then, an estate owner can provide an insurance company with between one to seven cents every year for every dollar needed to pay these estate expenses.  No matter how long a person lives, they rarely ever pay 100 cents on the dollar.

 

The discount method is the best overall method because it saves estate owners money in the long run and provides an immediate source of cash for heirs to pay the estate taxes and administrative costs.  Since the amount received at death is usually more than the estate has paid for the lump sum received, the estate actually saves money with the discount method.  Another added bonus with this method is that insurance policies can frequently be structured to accommodate a person’s unique premium payment requirements.

 

Regardless of an estate owners age, using life insurance is frequently the most economical method of providing the estate with the necessary liquidity to pay all expenses incurred upon the death of the estate owner.  Setting aside a mere one to two percent of an estate each year not only allows the estate owner to retain control of the estate, but also provides family and heirs a stress-free method to pay the exorbitant federal and state estate taxes.

 

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