Life Insurance for Estate Planning: Strategies to Protect Your Legacy

Why Life Insurance Matters in Estate Planning

Life insurance is not just about replacing income when someone dies. For people with significant assets, life insurance is one of the most important tools in estate planning. It creates immediate liquidity, funds trusts, offsets estate tax bills, and ensures that your heirs receive the wealth you intend to leave them.

Estates are often made up of illiquid assets such as real estate, businesses, retirement accounts, and investment portfolios. When the estate owner dies, the federal government may impose an estate tax of up to 40 percent on the value above the exemption threshold. That tax bill is due within nine months of death. Without enough cash on hand, heirs may be forced to sell family businesses, real estate, or other assets at unfavorable prices just to pay the tax.

Life insurance solves this problem by providing a guaranteed death benefit in cash. When structured correctly, the death benefit arrives quickly and can cover estate taxes, debts, legal fees, and other costs. This guide explains the major strategies for using life insurance in estate planning, including irrevocable life insurance trusts, survivorship policies, wealth replacement trusts, charitable giving, business succession, and generation-skipping strategies.

The 2026 Federal Estate Tax Exemption and the TCJA Sunset

Understanding the current estate tax landscape is essential before choosing a life insurance strategy. For 2026, the federal estate tax exemption is $13.99 million per individual. Married couples can effectively shield up to $27.98 million using portability, which allows a surviving spouse to use the deceased spouse's unused exemption.

However, this historically high exemption exists because of the Tax Cuts and Jobs Act of 2017, which roughly doubled the exemption. Key provisions of the TCJA are scheduled to sunset after 2025. If Congress does not act to extend or make these provisions permanent, the exemption could drop to approximately $7 million per person, adjusted for inflation. At the 40 percent federal estate tax rate, an estate worth $15 million could face a tax bill of over $3 million that would not have existed under the higher exemption.

This uncertainty makes planning essential. If the exemption drops, millions of additional estates will become subject to federal estate tax. Life insurance provides a hedge against this risk. Whether the exemption stays high or drops, having the right life insurance structure in place ensures your heirs are protected.

Estate Liquidity: The Foundation of Life Insurance Planning

Estate liquidity refers to having enough cash available to cover the costs that arise when someone dies. These costs include federal and state estate taxes, income taxes on retirement account distributions, probate fees, legal and accounting expenses, outstanding debts, and funeral costs. For large estates, these expenses can total millions of dollars.

Without adequate liquidity, heirs face a painful choice. They may need to sell the family home, liquidate a business, or dump investments at a loss to raise cash. These forced sales often happen at the worst possible time, when the family is grieving and the market may not be favorable.

Life insurance is the most efficient tool for creating estate liquidity. A whole life insurance policy or universal life policy provides a guaranteed death benefit that is paid in cash, usually within weeks of the claim being filed. The death benefit is income tax-free to the beneficiary. When the policy is owned by a properly structured trust, it can also be estate tax-free.

Consider a family whose estate is worth $20 million, mostly in commercial real estate and a family business. If the federal estate tax exemption drops to $7 million, the taxable estate would be $13 million, resulting in an estate tax bill of approximately $5.2 million. Without life insurance, the family might have to sell the business or properties under time pressure. A $5.2 million life insurance policy held in an ILIT would provide the exact cash needed, preserving the family's assets intact.

Irrevocable Life Insurance Trusts: Removing the Policy from Your Estate

An irrevocable life insurance trust (ILIT) is the cornerstone of most life insurance estate planning strategies. When you own a life insurance policy personally, the death benefit is included in your taxable estate. An ILIT solves this by transferring ownership of the policy to an irrevocable trust. Because you no longer own the policy, the death benefit is excluded from your estate.

Here is how an ILIT works in the estate planning context. You create the trust with the help of an estate planning attorney. The trust applies for a new life insurance policy on your life, with the trust as both the owner and beneficiary. You make annual gifts to the trust to fund the premium payments. The trustee sends Crummey letters to beneficiaries, notifying them of their temporary right to withdraw the gifted funds. After the withdrawal period passes, the trustee uses the money to pay the premium.

When you die, the trust collects the death benefit. Because the trust owns the policy, the death benefit is not part of your taxable estate. The trustee then distributes the funds according to the trust document. The trust can also be structured to provide liquidity to your estate by purchasing assets from the estate or lending money to the estate to pay taxes.

There are two important rules to keep in mind. First, the 3-year rule under IRC Section 2035 means that if you transfer an existing policy into an ILIT and die within three years, the death benefit is pulled back into your estate. To avoid this, have the ILIT purchase a new policy from the start. Second, you must not retain any incidents of ownership, such as the ability to change beneficiaries, borrow against the policy, or cancel coverage. Any retained control could cause the IRS to include the death benefit in your estate.

Survivorship Life Insurance for Married Couples

A survivorship life insurance policy, also known as a second-to-die policy, insures two people and pays the death benefit only after both have died. This type of policy is specifically designed for estate planning and is one of the most popular tools for married couples with taxable estates.

The logic behind survivorship policies is straightforward. Under current tax law, the unlimited marital deduction allows you to leave any amount of assets to your surviving spouse without incurring estate tax. The estate tax bill is deferred until the second spouse dies and the assets pass to the next generation. Since the tax is not due until the second death, the life insurance death benefit only needs to be available at that point.

Survivorship policies offer several advantages for estate planning. They are significantly less expensive than two individual policies because the insurance company only pays one claim after both insureds have died. Underwriting is also more favorable because the policy is based on the combined life expectancy of two people, so even if one spouse has health issues, the policy may still be available at a reasonable rate. When owned by an ILIT, the survivorship policy death benefit is excluded from both spouses' taxable estates.

A common strategy is for a married couple to create an ILIT that purchases a survivorship whole life or universal life policy. The couple makes annual gifts to the trust within the gift tax exclusion limits. After both spouses die, the trust receives the death benefit and uses it to pay estate taxes, provide for heirs, or both. This keeps the entire death benefit outside the taxable estate while ensuring that the cash is available exactly when it is needed most.

Wealth Replacement Trusts and Charitable Giving

Many wealthy individuals want to support charitable causes but are concerned about reducing the inheritance they leave to their families. Life insurance, combined with a charitable remainder trust and a wealth replacement trust, offers an elegant solution that satisfies both goals.

Here is how the strategy works. You transfer appreciated assets, such as stocks or real estate, into a charitable remainder trust. The trust sells the assets without triggering capital gains tax and invests the proceeds. You receive an income stream from the trust during your lifetime. When you die, the remaining trust assets go to the charity you designated. You also receive an upfront income tax deduction for the charitable portion of the gift.

The downside is that your heirs lose the assets that went to charity. This is where the wealth replacement trust comes in. You use some of the income from the charitable remainder trust to make gifts to an ILIT, which purchases a life insurance policy on your life. The death benefit replaces the value of the assets that will go to charity. Your heirs receive the life insurance proceeds tax-free through the trust, and the charity receives the remainder of the charitable trust.

This combined strategy can produce remarkable results. You get an income stream, a tax deduction, and the satisfaction of supporting a cause you care about. Your heirs receive the full replacement value of the donated assets through the life insurance trust. And the charity receives a substantial gift. It is one of the few strategies that truly benefits all parties involved.

There are other charitable strategies involving life insurance as well. You can name a charity as the beneficiary of a life insurance policy, which provides a large future gift at a relatively low annual premium cost. You can also donate an existing policy to charity and receive a tax deduction for the policy's fair market value. Each approach has different tax implications, so work with an estate planning attorney and tax advisor to choose the best option.

Life Insurance and Business Succession Planning

For business owners, a closely held business is often the single largest asset in the estate. The IRS values business interests at fair market value for estate tax purposes, and the resulting tax bill can be enormous. Without a plan, the estate may be forced to sell the business to pay the taxes, disrupting operations and destroying value that took decades to build.

Life insurance addresses business succession in several ways.

• Buy-sell agreements. Business partners purchase life insurance on each other. When one partner dies, the death benefit funds the purchase of the deceased partner's share from their estate. This ensures that ownership transfers smoothly and the surviving partners have the cash to complete the buyout without borrowing or liquidating business assets.
• Estate tax funding. A business owner can use an ILIT to hold a life insurance policy sized to cover the expected estate tax on the business value. This prevents the need to sell the business or take on debt to pay estate taxes. The heirs keep the business while the trust provides the cash for the tax bill.
• Equalizing inheritances. If one child is active in the business and others are not, the business owner can leave the business to the active child and use life insurance to provide equivalent value to the other children. This prevents family conflict over the business and ensures all heirs are treated fairly.
• Key person protection. If the business depends on a key individual whose death would significantly harm operations, a key person life insurance policy provides cash to help the business survive the transition, recruit a replacement, and maintain stability.

The specific structure depends on the type of business entity, the number of owners, and the overall estate plan. Cross-purchase agreements, entity-purchase agreements, and wait-and-see buy-sell agreements each have different tax implications. An experienced business succession attorney should be involved in structuring these arrangements.

State Estate Taxes and Their Impact on Planning

Even if your estate is below the federal estate tax exemption, you may owe state estate or inheritance taxes. Twelve states and the District of Columbia impose their own estate taxes, and six states impose inheritance taxes. Maryland is the only state that levies both.

State estate tax exemptions are often much lower than the federal exemption. Oregon and Massachusetts have exemptions of just $1 million. New York's exemption is approximately $6.94 million, but it has a cliff provision: if your estate exceeds the exemption by more than 5 percent, the entire estate is taxed, not just the amount above the exemption. State estate tax rates range from about 1 percent to 20 percent, depending on the state and the size of the estate.

Life insurance planning must account for both federal and state taxes. An ILIT can help reduce or eliminate both. If you live in a state with its own estate tax, the savings from using an ILIT may be significant even if your estate is well below the federal threshold. Understanding how life insurance is taxed at both the federal and state level is essential to getting the structure right.

States with estate taxes include Connecticut, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, Washington, and the District of Columbia. States with inheritance taxes include Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. If you own property in multiple states, you may be subject to estate tax in each state where you own real property.

Generation-Skipping Strategies with Life Insurance

The generation-skipping transfer tax is an additional tax imposed on transfers to people who are two or more generations below you, such as grandchildren. Without this tax, wealthy families could skip a generation and avoid estate tax at the children's level. The GST tax rate is 40 percent, the same as the estate tax rate, and it is imposed in addition to the estate tax.

Each person has a GST tax exemption that mirrors the estate tax exemption, currently $13.99 million in 2026. By allocating your GST exemption to a trust funded with life insurance, you can create a large pool of wealth that passes to grandchildren and future generations without incurring the GST tax or estate tax at each generation.

A dynasty trust, sometimes called a generation-skipping trust, is the vehicle most commonly used for this purpose. The trust is designed to last for multiple generations, potentially in perpetuity in states that have abolished the rule against perpetuities. When an ILIT is structured as a dynasty trust and funded with a life insurance policy, the death benefit enters the trust free of income tax, estate tax, and GST tax. The trust can then invest and grow the assets, making distributions to beneficiaries across generations according to the trust terms.

For example, suppose a couple allocates $10 million of their combined GST exemptions to a dynasty trust that purchases a survivorship life insurance policy with a $10 million death benefit. After both spouses die, the trust receives $10 million free of all transfer taxes. If the trust grows at 6 percent annually and makes modest distributions, it could provide significant wealth to grandchildren, great-grandchildren, and beyond, all without further estate or GST tax.

The effectiveness of this strategy may change if the TCJA sunsets and the GST exemption drops. Planning now while the exemption is at its highest level allows you to lock in the maximum tax-free transfer to future generations.

Choosing the Right Type of Life Insurance for Estate Planning

Not all life insurance products are equally suited for estate planning. The right choice depends on your goals, budget, and the specific strategy you are implementing.

• Whole life insurance. This is the most common choice for estate planning. It provides a guaranteed death benefit, guaranteed cash value growth, and level premiums for life. The predictability of whole life makes it ideal for funding ILITs and other trust-based strategies. The policy will be in force when you die regardless of when that happens, as long as premiums are paid.
• Universal life insurance. Universal life offers more flexibility in premium payments and death benefit amounts. Guaranteed universal life policies provide lifetime coverage with lower premiums than whole life but typically have minimal cash value. This can be a good option if you want permanent coverage at a lower cost and do not need the cash value component.
• Survivorship life insurance. As discussed earlier, survivorship policies insure two lives and pay after both deaths. They are less expensive than individual policies and are specifically designed for the estate planning context where the tax event occurs at the second death.
• Term life insurance. Term insurance is generally not ideal for estate planning because it expires after a set period. However, it can serve as a temporary bridge. For example, if you transfer an existing policy into an ILIT and face the 3-year rule, a term policy can provide coverage during that waiting period. Term insurance can also supplement permanent coverage while children are young or a mortgage is outstanding.

For most estate planning purposes, permanent life insurance is preferred because you need the death benefit to be available whenever you die, whether that is in 5 years or 40 years. The policy must remain in force for the strategy to work. Work with a financial advisor and insurance professional to determine the right product and coverage amount for your specific situation.

How the ILIT Provides Liquidity to the Estate

One common question is how the ILIT, which is separate from the estate, actually provides cash to pay estate taxes. The death benefit belongs to the trust, not the estate, so it cannot be used directly to pay estate taxes without careful structuring.

There are two primary methods for getting the cash from the ILIT to the estate.

• The trust purchases assets from the estate. The ILIT can buy illiquid assets, such as real estate or business interests, from the estate at fair market value. This gives the estate the cash it needs to pay taxes while transferring those assets to the trust for the benefit of the heirs. This must be done at fair market value to avoid tax problems.
• The trust lends money to the estate. The ILIT can make a loan to the estate at a reasonable interest rate. The estate uses the borrowed funds to pay taxes and repays the loan over time from estate assets. The loan must carry an arm's-length interest rate to satisfy IRS requirements.

Both methods are legitimate and commonly used. The trust document should include provisions authorizing the trustee to purchase assets from or make loans to the estate. These provisions must be carefully drafted to avoid the IRS treating the death benefit as part of the taxable estate. Your estate planning attorney will ensure the trust language is correct.

Common Estate Planning Mistakes with Life Insurance

Life insurance estate planning is powerful but only when executed correctly. Here are the most common mistakes that can undermine your plan.

• Owning the policy personally. If you own the policy when you die, the entire death benefit is included in your taxable estate. This is the most basic and most expensive mistake. The policy must be owned by an ILIT or another entity to be excluded from your estate.
• Failing to plan for the TCJA sunset. Many people assume the current $13.99 million exemption will last forever. If the TCJA expires and the exemption drops to $7 million, estates that were previously safe could face millions in taxes. Plan for the lower exemption scenario.
• Ignoring state estate taxes. Many people focus only on the federal exemption and overlook their state's estate or inheritance tax. If you live in a state with a $1 million exemption, even a modest estate could face state estate tax.
• Not keeping the ILIT properly maintained. Crummey letters must be sent every year. Premiums must be paid through the trust. Tax returns must be filed. Neglecting any of these ongoing requirements can jeopardize the tax benefits of the trust.
• Underestimating the coverage amount. The coverage amount should account for estimated estate taxes, settlement costs, and any other financial needs. If the exemption drops, the tax bill could be significantly larger than expected. Consider purchasing more coverage than you think you need, or build in flexibility through adjustable universal life policies.
• Waiting too long to start. Life insurance premiums increase with age, and health problems can make coverage unaffordable or unavailable. The best time to set up an ILIT and purchase a policy is when you are relatively young and healthy. Waiting until retirement age significantly increases the cost.

Building Your Estate Planning Team

Life insurance estate planning is not a solo endeavor. It requires a coordinated team of professionals working together to create and implement the right strategy.

• Estate planning attorney. This professional drafts the trust documents, ensures compliance with federal and state tax laws, and coordinates the legal aspects of the plan. Choose an attorney who specializes in estate planning and has experience with ILITs and advanced strategies.
• Financial advisor. A financial advisor helps evaluate your overall financial picture, determine the right coverage amount, and integrate the life insurance strategy with your broader investment and retirement plan.
• Insurance professional. A licensed insurance agent or broker helps you select the right policy type, compare carriers, and secure the best rates. They manage the application process and coordinate with the trust.
• Tax advisor or CPA. A tax professional ensures that the strategy achieves the intended tax benefits, prepares trust tax returns, and advises on gift tax implications of premium payments.

These professionals should communicate with each other regularly. The estate planning attorney needs to know what type of insurance is being purchased. The insurance professional needs to understand the trust structure. The tax advisor needs to review the whole plan. When everyone is aligned, the strategy works seamlessly. When they work in silos, costly mistakes can occur.

Key Takeaways

Life insurance is one of the most versatile and effective tools in estate planning. It provides liquidity to pay estate taxes without forcing the sale of family assets. When held in an ILIT, the death benefit is excluded from your taxable estate, potentially saving your heirs hundreds of thousands or millions of dollars in federal and state estate taxes.

Survivorship policies are ideal for married couples because they pay out when the estate tax is actually due, at the second death, and at a lower premium cost. Wealth replacement trusts allow you to give generously to charity while making your heirs whole through life insurance. Business owners can use life insurance to fund buy-sell agreements, cover estate taxes on business value, and equalize inheritances among children.

The 2026 landscape adds urgency to this planning. With the TCJA estate tax provisions potentially sunsetting, the exemption could drop from $13.99 million to approximately $7 million per person. This means millions of additional estates could be subject to the 40 percent federal estate tax. State estate taxes add another layer of complexity, particularly in states with exemptions as low as $1 million.

Generation-skipping strategies using life insurance and dynasty trusts can extend the benefits of your planning across multiple generations. The key is to act while exemptions are high, health is good, and premiums are affordable. Work with a team of estate planning professionals to design a strategy that protects your legacy and ensures your wealth reaches the people and causes you care about most.