How to Leave a Life Insurance Inheritance for Your Kids

As part of developing your last will and testament in Canada, leaving a life insurance inheritance for your kids is likely an important goal as you plan your estate. Using a life insurance policy to supplement any other assets you wish to pass down can provide unique benefits compared to simply relying on your investments or real estate.

In this guide, we’ll explore how you can leverage life insurance to leave a tax-free inheritance for your kids or grandkids. You’ll learn the advantages of designating your children as beneficiaries on a life insurance policy intended to provide inheritance funds. We’ll also cover how to determine the right death benefit amount, choose suitable permanent or term life insurance, name minor beneficiaries properly, and coordinate the life insurance inheritance as part of your overall estate plan.

Why Use Life Insurance for Inheritance Planning?

Here are six key advantages of using life insurance to leave an inheritance:

The Death Benefit Passes Directly to Beneficiaries

A major benefit of life insurance is that the death benefit is paid directly to the beneficiaries you name on the policy. This allows the funds to bypass probate, avoiding potentially lengthy delays and legal fees associated with the estate settlement process.

For example, if you name your adult child as the sole beneficiary on a $500,000 life insurance policy, they will receive the full $500,000 directly once the claim is approved. The money does not need to go through probate first before reaching them.

Income Tax-Free for Beneficiaries

Another big advantage of using life insurance for inheritance planning is that the death benefit payout is income tax-free for the beneficiaries who receive it.

If your kids were to inherit a $500,000 investment portfolio from your estate, they may have to pay income taxes on the capital gains generated over the years. With a life insurance inheritance, they get the full sum tax-free.

Quick Access to Funds

With life insurance, your beneficiaries gain quick access to the inheritance funds, often within a few weeks of filing the claim. This can be tremendously helpful for covering urgent expenses like a mortgage or funeral costs.

Compare this to the months or even years it can take for beneficiaries to receive inheritance assets that must go through lengthy probate proceedings first.

Supplement Other Assets

For many families, life insurance provides a tax-free inheritance pool of funds that can supplement other assets being passed down.

For example, you may have a retirement portfolio and property you wish to leave to your children. Adding a life insurance policy provides an additional, guaranteed inheritance asset they can count on.

Guaranteed Death Benefit

Unlike investments, the death benefit from a life insurance policy is fixed and guaranteed. This gives your beneficiaries assurance that they will receive the full amount no matter what happens in the financial markets.

Term and permanent life insurance policies with fixed death benefits are best for guaranteeing a specific inheritance amount.

Equalize Inheritances

Some parents want to provide equal dollar amounts to children using the inheritance. However, if the assets in the estate vary greatly in value, this can be difficult to achieve.

Life insurance provides a straightforward way to equalize children’s inheritances. Simply take out policies of equal value in your life for each child to smooth out the distribution of assets.

How Does Life Insurance Inheritance Work?

First, it’s helpful to understand the basics of how life insurance inheritance works:

• Choosing a Death Benefit Amount – When applying for life insurance, you select a total death benefit amount to be paid out to beneficiaries upon your death. Common amounts range from $50,000 up to $1 million or more.
• Naming Beneficiaries – The life insurance application includes a beneficiary designation section where you list who should receive the death benefit funds. You can split the amount between multiple beneficiaries if desired.
• Premium Payments – To keep the policy active, you’ll make periodic premium payments to the life insurance company. Rates are based on factors like age and health.
• Filing a Claim – Upon your death, your beneficiaries file a claim with the insurance company and submit a death certificate.
• Payment of Death Benefit – Once approved, the insurance company pays out the death benefit amount directly to the listed beneficiaries. This is typically in the form of a lump sum payment by default.

Some policies allow beneficiaries to receive the payouts in installments over time instead of a lump sum if requested. The beneficiaries can decide which option works best for them.

Keeping Beneficiary Designations Up-to-Date

It’s critical to keep your policy’s beneficiary designations current. Otherwise, the payout may end up going to an unintended or deceased person instead of your intended heir if you pass away.

Review beneficiaries whenever a major life event occurs, like a birth, death, marriage, or divorce in the family. Contact the insurance company to file change forms as needed.

What Type of Life Insurance is Best for Inheritance?

When it comes to inheritance planning, permanent life insurance policies that last a lifetime are generally the best options.

Here’s an overview of the positives and limitations of different policy types:

Permanent Life Insurance For Inheritance Planning

Includes whole life, universal life, indexed universal life, and variable life policies.

Pros for Inheritance Planning

• Lifelong coverage
• Cash value accumulation
• Fixed death benefit amount

Cons

• Substantially higher premiums than term life insurance

Term Life Insurance For Inheritance Planning

Provides coverage for a set period, such as 10 or 30 years.

Pros for Inheritance Planning

• Affordable premiums
• Sufficient for covering temporary needs

Cons

• Expires after term length, leaving no inheritance
• No cash value accumulation

While permanent life insurance is recommended for leaving an inheritance, term life insurance can also align with your goals, depending on the situation.

For instance, you may want a term life policy to cover your family’s living expenses until your children become adults. You may also ladder term policies to provide coverage for university tuition costs.

A licensed life insurance agent can assess your financial situation and inheritance goals to help select suitable policies.

How Much Life Insurance Do You Need for Inheritance?

Determining the right death benefit amount for inheritance purposes depends on five key factors:

• Size of Estate – If you have substantial real estate, retirement accounts, or other assets, a smaller life insurance policy may supplement your estate sufficiently. With a modest estate, larger coverage provides greater inheritance funds.
• Number of Heirs – If you have multiple children, grandchildren, or beneficiaries to provide for, purchasing higher coverage lets you distribute larger inheritances.
• Future Changes – Take into account that your estate value may increase in the future, decreasing the relative impact of a life insurance inheritance. Securing additional coverage down the road can offset this.
• Insurability Factors – Health issues or simply aging can make getting approved for life insurance more difficult or costly over time. Locking in greater coverage earlier on when rates are lower may be advisable.
• Budget – Your premium budget impacts how much coverage you can realistically take on. Prioritize securing enough life insurance for must-have inheritance goals first.

Consulting with an insurance professional or estate planning advisor can help you analyze these factors and dial in an appropriate life insurance amount tailored to your family’s specific situation.

Setting Up Your Children as Beneficiaries

Most parents name their children or grandchildren as the beneficiaries of the life insurance policies intended for their inheritance. Here are three tips for setting up minor beneficiaries properly:

Setup a Trust

A common way to leave a life insurance inheritance to minor children is to create a trust which is designated as the policy beneficiary.

Upon your death, the insurance payout goes to the trust. The trustee then manages the distribution of funds to your children according to your instructions in the trust documents.

Trusts allow you to place conditions around the inheritance, like staggered payouts at certain ages or limiting how the funds are spent. The trustee has a fiduciary duty to carry out your wishes.

Use a UTMA Account

The Uniform Transfers to Minors Act (UTMA) offers another option. With this method, you designate a custodian to manage the life insurance payout for the child under UTMA rules.

When the child reaches adulthood, usually at 18 or 21 years, depending on the state, the funds become theirs to control fully. Compared to a trust, the custodian has less discretion over using the inheritance funds.

No matter which approach you choose for minors, name a contingent beneficiary in case your child passes away before you do. This ensures the life insurance funds flow to a backup person of your choosing rather than back to your estate by default.

Keep Designations Updated

Remember to review your beneficiaries whenever a major life event occurs and file beneficiary change forms with the insurer when needed. Keeping designations current avoids situations where an ex-spouse or deceased relative receives your child’s inheritance.

Integrating Life Insurance Into Your Overall Estate Plan

The best approach is to work with a professional estate planning advisor when incorporating life insurance into your financial legacy. Here are five key factors to consider:

• Tax Optimization – They can help structure your estate to minimize taxes using applicable credits, deductions, trusts, and entities. Life insurance can help offset capital gains or other taxes.
• Asset Allocation – Look at your overall asset mix, which includes real estate, retirement accounts, investments, and other holdings. Gauge whether life insurance balances your portfolio well for inheritance purposes.
• Debt Reduction – Your advisor can project whether your life insurance and other estate assets will sufficiently cover mortgage debts, loans, liens, and credit card balances.
• Final Expenses – Ensure your estate has adequate funds for probate costs, funeral fees, medical bills, and other final expenses so loved ones aren’t left paying.
• Business Holdings – For business owners, life insurance can help provide liquidity for heirs to retain a family business. Consult your accountant and financial planner.

With professional guidance, you can integrate life insurance inheritance planning effectively into your broader estate strategy and family financial goals.

Looking ahead and planning thoughtfully ensures your loved ones are provided for, and your final wishes are honoured. For additional guidance on estate planning and securing your legacy, explore these related topics:

• Receiving an Inheritance in Canada
• What Happens To Bank Accounts After Death In Canada?
• Average Funeral Cost in Canada
• Inheritance Law in Canada
• What Happens If You Die Without A Will In Canada?

Summary

Structuring a life insurance inheritance for your children or grandchildren takes some planning. But the tax-free payout, probate avoidance, and guaranteed funds make it well worth the effort.

Work with a knowledgeable insurance professional and estate planning advisor to select suitable policies, properly designate young beneficiaries, and coordinate with your broader financial legacy.

The peace of mind from knowing you’ve secured your family’s future and put your children on the path toward financial security makes life insurance inheritance an extremely rewarding part of many parents’ estate plans.

Frequently Asked Questions about Leaving a Life Insurance Inheritance for Your Kids