Life Insurance in Farm Transition Planning – Part 1

Farmers often face the challenge of being “land rich, cash poor.” While they may have significant wealth tied up in land and other assets, they can lack sufficient cash to cover expenses, taxes, or distributions when planning for the farm’s transition to the next generation. This “land rich, cash poor” dilemma can complicate farm transition and succession planning, creating potential obstacles for a smooth handover of the farm.

Life insurance can provide a solution to this problem by introducing liquidity into an estate or trust, which can be used to cover expenses, taxes, and distributions to heirs. By incorporating life insurance into a farm transition plan, legal complexities and costs can be reduced, and the transition process can be streamlined. However, life insurance, like any estate planning tool, may be appropriate in some situations but not in others. This bulletin aims to explain different types of life insurance and how they can be used effectively in farm transition planning. Given the complexities of life insurance policies, it is essential to work with insurance and legal professionals to ensure that life insurance is appropriately included in your plan.

Types of Life Insurance Policies

Term Life Insurance:
Term life insurance provides coverage for a specific period (e.g., 10, 20, or 30 years). If the insured passes away during the term, the policy pays a death benefit to the beneficiaries.

• Pros: Lower premiums compared to permanent life insurance; simple and straightforward; ideal for temporary needs like covering a mortgage or debt.
• Cons: No cash value accumulation; coverage ends at the term’s expiration unless renewed, often at a higher premium; not ideal for long-term estate planning.

Whole Life Insurance:
Whole life insurance provides lifetime coverage with a guaranteed death benefit and includes a cash value component that grows over time.  Typically, the premiums are fixed for the life of the policy.

• Pros: Permanent coverage with a guaranteed death benefit; cash value can be accessed through loans or withdrawals; fixed premiums for the life of the policy.
• Cons: Higher premiums compared to term life insurance; cash value grows slowly in the early years; limited flexibility in adjusting the death benefit or premiums.

Universal Life Insurance:
Universal life insurance offers permanent coverage with more flexibility than whole life. Policyholders can adjust premiums and death benefits within certain limits and earn interest on the cash value.

• Pros: Flexible premiums and death benefits; cash value accumulation with potential for higher returns; can be tailored to specific estate planning needs.
• Cons: More complex than whole life insurance; interest rates may fluctuate, affecting cash value growth; requires careful management to avoid policy lapse.

Variable Life Insurance:
Variable life insurance provides permanent coverage with investment options for the cash value. Policyholders can invest the cash value in various sub-accounts, such as stocks and bonds.

• Pros: Potential for higher returns through investment options; tax-deferred growth of the cash value; permanent coverage.
• Cons: Higher risk due to market exposure; policy performance depends on the chosen investments; requires active management and carries higher fees.

Difference Between Universal Life and Variable Life Insurance

Universal life and variable life insurance are both types of permanent life insurance, but they differ in flexibility, investment options, and risk. Universal life offers adjustable premiums and death benefits, with cash value growth based on an interest rate set by the insurer. This makes it a more predictable option with lower risk, though it offers moderate growth potential as the cash value isn’t directly tied to market performance. Variable life, on the other hand, requires fixed premiums but allows policyholders to invest the cash value in various sub-accounts, offering the potential for higher returns. However, it introduces greater risk as the cash value fluctuates with the market, and there’s no guaranteed minimum cash value. Variable life policies are also more complex, requiring active management and often incurring higher fees. In summary, universal life provides predictability and flexibility, while variable life offers the potential for higher returns with greater risk and complexity.

Second-to-Die Life Insurance Policy

A second-to-die life insurance policy, also known as survivorship life insurance, covers two individuals, typically a married couple, and pays the death benefit only after both individuals have passed away.

• Pros: Second-to-die policies generally have lower premiums than two individual life insurance policies since the insurer pays out only after both insured individuals have died, reducing their risk exposure. Additionally, they are often easier to obtain for couples where one partner has health issues, as the payout depends on both individuals passing away.
• Cons: The death benefit is delayed until both individuals have passed, which may not provide financial assistance when the first spouse dies. This delay makes the policy less useful for covering immediate expenses or providing cash flow to the surviving spouse. Furthermore, second-to-die policies do not offer cash flow benefits during the policyholders’ lifetimes, as the payout occurs only after death.

In the next post, we will discuss the advantages and disadvantages of life insurance as well as strategies to incorporate life insurance into a farm transition plan.