Life Insurance in Estate Planning
Life insurance is a legal contract between the insurance company and the insured. On the condition that the insured pays the premium, the insurance company will pay the sum assured to the rightful owner of the policy if an unplanned risk (for example, death, critical illness or total permanent disability) happens after a stated waiting period. Examples of such rightful owners are: the owner of the policy, the estate of the insured, the trust or the beneficiary. The sum assured settlement is in cheque and is usually denominated in Singapore dollars. Some insurance companies do issue life policies in US$.
Life insurance occupies a unique place in estate planning which is not replaceable by other assets. This is because several of Singapore’s statutes and case laws happen to give unique and advantageous legal positions to a life policy which are not available to other assets. Therefore, a properly structured life policy can magnify your estate and provide a smooth estate transfer to the next generation without problems typically experience by other assets. The 4 main advantages of life insurance are as follows:
- Creates & guarantees immediate capital to your estate for your loved ones.
- Provide liquidity to your estate without probate
- Proceeds can be protected from your estate’s creditors
- Policy can be nominated or assignable to third party to facilitate estate distribution objectives.
Create & Guarantee Immediate Capital to your estate for your loved ones.
Life insurance creates and guarantees immediate capital to your estate for your loved ones upon your death. This is important because in the absence of an insurance capital, a family typically has to liquidate certain assets, if any, to fund their livelihood when the key man of the house dies.
A common example is the death of a working husband. The deaths of working husbands in families usually cause financial hardship to the family. Realistically, most of our family assets are acquired through debt or credit. For example, it is very common for couples to take up a mortgage on the family house. The death of one working party can cause financial hardship on the other family members. The debt will still have to be paid, and almost all mortgage contracts will bind the liability on to the other party of the house, who is usually the wife.
Secondly, not many of us have ample cash capital sitting in the bank to generate income. Assuming your family needs $5,000 per month to live for the next 20 years. You would need a seed capital of $2,000,000 (assuming capital is intact, and the income drawn on the capital is 3% p.a.).
In view of the high cost of living in Singapore, not many families have that kind of seed capital without liquidating assets. Life insurance is precisely designed to solve this problem where no other financial products can do: To create and guarantee an immediate capital for family financial security when you die.
Another benefit of life insurance is that the sum assured paid out of a life insurance contract comes unencumbered with other liabilities. In other words, a $1M sum assured from a life policy is $1M upon your death; while a $1M in your bank saving account might not be $1M if you have other un-discharged liabilities with the bank. This is because your savings in the bank could have been encumbered to your overdraft, credit card or even your mortgage; your property is usually encumbered with a mortgage. If you are a businessman, your personal assets could be encumbered by your business liabilities through your personal guarantee with the bank.
How much life insurance should you buy for your estate plan? You might want to ask your spouse this question: “How much capital do you need to have to feel secure if I die tonight?”
Provide liquidity to your estate without probate or a letter of administration
Your assets will need to go through probate or administration before they can be distributed to your loved ones. There are statutory exceptions to life policy proceeds, which make it a valuable estate planning tool. In other words, a life policy provides immediate liquidity to your estate when you die.
This is illustrated with the following laws:
- Section 61 of the Insurance Act allows an insurance company to pay out up to $150K of the sum assured to your estate (through proper claimant) without probate or a letter of administration.
- Section 49M of the Insurance Act allows an insurance company to pay the entire sum assured to your designated beneficiary in the revocable nomination form without probate or a letter of administration.
- Section 49L of the Insurance Act allows an insurance company to pay the entire sum assured to your designated trustee(s) in the irrevocable nomination form without probate or a letter of administration.
- If a life policy is assigned to a third party, which is legitimate under Policies of Assurance Act, the sum assured will be paid entirely to the owner of the life policy without the need for probate or a letter of administration.
When all other personal assets are frozen in the estate pending for probate or a letter of administration, life insurance proceeds are your only source of liquidity for your loved ones. This unique advantage of a life policy is to be appreciated greatly, because a lack of liquidity could cause your estate to be insolvent, or bring about the need to forcedly sell other assets in order to raise funds to pay the debts. A forced sale is rarely advantageous. Having a life policy would ensure that the estate need not dispose of property at a time not of its choosing.
Proceeds can be protected from your estate’s creditors
We cannot be sure that upon our death, our estate will be free from creditors. Such unfortunate situations can arise from unpaid debt, lack of fulfillment of personal guarantor, or loss of a law suit. In such situations, the creditors can issue a caveat on the estate, which will further delay the estate settlement and ultimately, lead to dilution of the value of the estate.
Section 49L of the Insurance Act allows a life policy to be structured as a statutory trust policy. To meet this requirement, the policy must be expressed to benefit the spouse and/or his/her children. The life insurance proceeds pay out under this condition will be protected from creditors.
Prior to 1st September 2009, the proceeds payable under a life policy (which satisfies Section 73 of the Conveyancing and Law of Property Act) are also protected from the claims of the policyholder’s creditors. To meet the requirements of section 73, the policy must also be expressed to benefit the spouse of the policyholder and/or his/her children. If the policy is expressed to benefit persons in addition to these parties, the proceeds will not be protected by this section. Currently, this advantage is provided by Section 49L of the Insurance Act.
Policy can be nominated or assignable to 3rd party to facilitate estate distribution objectives
There are situations where estate distribution through a Will is inconvenient, like when you have a non-traditional familial relationship (e.g. when you are co-habiting with your partner), or if you are a Muslim, in which case some members of your family could be in a disadvantageous financial position if your estate is distributed according to Faraid (i.e. Islamic law of estate distribution). Other inconvenient situations include the circumstance where you have an illegitimate child whom you want to provide for, and the situation where you are be in a second marriage and would like to provide for your children from your previous marriage.
A properly structured life policy could pass the sum assured to the planned person through revocable or irrevocable nomination or assignment of policy. The proceeds can be paid out without probate, letter of administration or certificate of inheritance. In some cases where family relationships are tense, this unique feature of life policies can help minimise or avoid potential family conflicts resulting from estate distribution upon your death.
These 4 advantages show that a properly structured life policy can perform estate creation, estate protection and estate distribution functions of estate planning. No other financial assets can replace life policy in these areas.