Your wealth means more to you than a specific number in a bank account. A large portion of that wealth is likely wrapped up in assets that are meaningful to you. Maybe it’s a business you’ve grown from the ground up, special real estate holdings, or a collection that you’re proud of.
When it’s time to pass that wealth on, even the most successful families can be caught off guard with major estate tax bills and not enough liquid assets to cover them.
The IRS gives heirs nine months to pay estate taxes, and they don’t make exceptions for assets tied up in private stocks, property, or collectibles. If your heirs find themselves under that kind of pressure to come up with capital, they may make rushed decisions, like selling something you hoped would stay in the family.
The good news is, you can make a plan to make sure your legacy stays intact.
Life insurance for estate liquidity can provide the cash your heirs need, exactly when they need it. Let’s take a closer look at how that works, and how to decide which type is the right fit for you.
Getting Started with Life Insurance for Estate Liquidity
What’s the real risk if most of my wealth is in a business or other illiquid assets?
- Estate taxes are due within nine months of death, which can put pressure on your heirs.
- The IRS doesn’t accept private company shares or buildings as payment.
- Your heirs may be forced to sell assets quickly, take on debt, or split ownership in ways that damage the business.
How does life insurance solve that problem?
- Provides immediate, tax-free cash to pay estate taxes without touching legacy assets.
- Keeps businesses intact for heirs who want to run them.
- Creates fairness among heirs when some are involved in a family business and others aren’t.
What do I need to do to make this strategy work?
- Use a permanent life insurance policy (whole, universal, or second-to-die) for guaranteed coverage.
- Own the policy through an Irrevocable Life Insurance Trust (ILIT) to keep the proceeds out of your taxable estate.
- Work with advisors to align the policy size and structure with your estate tax exposure and liquidity goals.
Understanding Liquidity in Life Insurance
When we talk about liquidity in life insurance, we’re talking about how quickly and easily the policy provides cash when it’s needed. Life insurance death benefits become available to beneficiaries within weeks of filing a claim, unlike other assets that may require months to sell or convert.
Some permanent life insurance policies build cash value that you can access during your lifetime, in addition to providing death benefits to your beneficiaries. These types of policies will need to mature for several years, however, before any meaningful liquidity becomes available.
Hypothetical Example: The Mitchell Family
Here’s a hypothetical example of how the liquidity of life insurance comes into play in a common estate planning scenario:
Tom Mitchell spent 35 years building a successful manufacturing business in New England. Over the years, his company grew to be worth $15 million. Tom has two kids.
- Jake works in the business and has been involved for the last 10 years, preparing to take over.
- Emily chose a different path. She’s an attorney and has no interest in running the company.
Now, here’s the problem:
Tom’s total estate is just the business and his home, which are valued together at $15 million. In 2025, you can die with up to $13.99 million without having to pay federal taxes. Since his estate is over that amount, his heirs (Jake and Emily) will owe taxes on that excess amount.
The federal estate taxes come out to roughly $345,000. On top of that, this business is in Rhode Island, which has a significantly lower estate tax exemption. This could add another $1.2 to $1.5 million in state estate taxes.
Jake wants to keep the business, but there’s no liquidity to pay this tax bill. The IRS doesn’t take shares in a private company as payment, and they require the money within nine months.
What are the options?
- Sell the business (which Jake doesn’t want to do.)
- Take out a high-interest loan to pay estate taxes.
- Dip into personal savings, which might not be enough.
Instead of leaving his heirs with frustrating financial choices to make during an emotional time, Tom could have set up a life insurance plan to handle the estate taxes. Here are a few ways Tom could have structured his life insurance to solve for both the estate taxes and providing a fair inheritance for both Jake and Emily.
- If Tom had a $2M life insurance policy that was outside of his estate, that would be enough to cover the estate tax bill. Jake and Emily would still inherit the business split 50/50.
- If Tom had a $20M life insurance policy that was outside of his estate, he could leave $15M in cash to Emily and leave 100% of the business to Jake. This way they get the same amount, but don’t have to split a business that Emily doesn’t want to be involved in. And there would still be cash leftover to pay the estate taxes.
This type of situation could happen to anyone with an illiquid estate. Real estate investors, people with private equity holdings, or even those with valuable collectibles could be leaving their heirs in financial limbo when estate taxes come due.
How Life Insurance Solves the Problem
The Benefits of Permanent Life Insurance
The right life insurance policy provides instant liquidity when it matters most. Permanent life insurance (whole life, universal life, or second-to-die) can:
- Provide immediate income (and estate tax-free if structured properly) to cover estate taxes.
- Prevent your heirs from having to sell assets under pressure.
- Create an equal inheritance for heirs who aren’t involved in the business.
- Avoid saddling your business with unnecessary debts.
In Tom’s case, a $2 million life insurance policy could have covered estate taxes, whereas a $20M policy would help equalize the inheritance for Emily, and allow Jake to keep the business. In this scenario, the family would have avoided financial chaos and the added emotional turmoil that came with it.
Where Term Life Insurance Can Still Play a Role
Many business owners hesitate to buy permanent life insurance because of the cost. But even term life can be valuable in certain situations:
- If you expect your taxable estate to shrink over time due to gifting, business succession, or just enjoying life.
- If you need temporary coverage while you’re still accumulating wealth, but expect to self-fund estate taxes later.
- If a business is in transition, such as a planned sale within 10 years.
Structuring Ownership to Maximize Benefits
A life insurance policy alone isn’t enough. You’ll also need to structure it correctly to maximize the benefit and minimize estate tax exposure.
If you own the policy personally, the death benefit gets included in your taxable estate, which can defeat the whole purpose. You’ll want to use an Irrevocable Life Insurance Trust (ILIT) to keep the insurance payout outside your taxable estate and provide direct, tax-free benefits to your heirs.
Setting Up Your Irrevocable Life Insurance Trust (ILIT)
You’ll need to carefully set up your ILIT to get the tax benefits you’re aiming for. Here are the steps you’ll need to take, and a little about the mechanics behind them.
Create the ILIT and Choose a Trustee
The trust needs to be irrevocable, meaning the grantor (insured) gives up control over the trust and its assets. You’ll also need to name a trustee to manage the trust. This could be a family member, a lawyer, or even a corporate trustee. They’ll handle the paperwork, policy management, and make sure everything plays out as planned when the time comes.
Fund the ILIT with Annual Exclusion Gifts
To keep the life insurance policy funded, you’ll make annual gifts to the ILIT. The trustee uses those gifts to pay the policy premiums. There’s a specific way to do this using the Crummey Letters strategy. This strategy gives the beneficiaries temporary access to the gift, which makes it qualify for the annual gift tax exclusion (up to $19,000 per beneficiary in 2025.) In reality, the beneficiaries don’t usually take the money out. It stays in the trust to keep the policy going.
ILIT Purchases Life Insurance Policy
The ILIT buys the life insurance policy, with you as the insured. You can also transfer an existing policy into the trust, but you’ll need to be aware of the three-year rule. If you pass away within three years of the transfer, the IRS pulls the death benefit of transferred policies back into your taxable estate. To steer clear of that, it’s often cleaner to have the ILIT purchase a brand-new policy from the start.
Trustee Manages Payout at Death
When you pass away, the insurance company pays the death benefit directly to the ILIT completely tax-free. Then, the trustee steps in and follows your instructions. Maybe that’s paying estate taxes, distributing cash to your heirs, or covering other final expenses.
In the Mitchell family example, Jake could have used these funds to buy out Emily’s share of the family business to keep everything fair without having to sell the company.
Consider Second-to-Die Policies for Married Couples
If you’re married, keep in mind that the estate tax bill typically hits when both spouses have passed. In this case, a second-to-die life insurance policy can be beneficial. It pays out after the second death, which is when the estate taxes are due anyway. It’s also usually more affordable than taking out two separate policies.
Final Thoughts
Strategically navigating life insurance and estate planning is an important step you can take to make sure your legacy continues the way you intended it. Using the benefits of liquidity in life insurance can also help prevent your heirs from having to make tough financial decisions under the pressure of IRS timelines during a difficult time they should be spending together.
At SK Wealth, we’ve helped families and business owners plan for big life transitions for over 25 years. Through our Integrated Financial Advantage™ process, we coordinate your financial, tax, and legal strategies into one cohesive plan. Let’s make sure your family inherits your legacy, not a financial headache.
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