Can life insurance be used as an estate planning tool?

Dear Liz: I am 70 and my wife is 59. My pension covers us for both our lifetimes. We have no debt. My wife and I do not need the required minimum distributions I will soon have to start taking from my 457 deferred compensation plan, which is currently worth $1 million. I planned to invest these distributions in an index fund to leave to our son. My accountant recommends instead that I buy a joint whole life insurance policy for me and my wife because it will be tax free when our son inherits our estate years from now. Does it make sense to buy insurance as an estate planning tool?

Answer: Does your accountant sell insurance on the side, by any chance?

Because a tax pro should know that the money in that index fund would get a so-called step up in tax basis when you die and your son inherits the account. If he promptly sold the investments, he wouldn’t owe any taxes on the growth in the account (the capital gains) that happened while you were alive. Even if he hangs on to the investments for a while, he would owe capital gains tax only on the growth in value since your death. That’s a pretty awesome deal.

If you buy life insurance, by contrast, you’d have to weigh any tax benefit against the not-insubstantial amount you’d pay the insurer for coverage. At your ages, such a policy would be far from cheap.

Any time someone suggests that you buy life insurance when you don’t actually need life insurance, you would be smart to run the proposed policy past a fee-only advisor — one who doesn’t receive commissions or other incentives to sell insurance.

There’s an outside chance that your accountant recommended a permanent life insurance policy for estate tax purposes. These taxes will be an issue only if the combined estate of you and your wife is worth more than $10 million. If that’s the case, you should consult an estate planning attorney about your options.