Why Do Rich People Buy Life Insurance?

With the aging population of the U.S., questions of estate planning have grown in importance. For the wealthiest Americans, the federal estate tax can destroy almost half of their wealth. Because of the special tax treatment of death benefits, life insurance has been used for many years to mitigate the impact of estate taxes. This paper looks at actual life insurance holdings to determine if there is evidence that life insurance is being used for this purpose. The results suggest that life insurance is being used for estate tax purposes and this motivates modeling of wealth accumulation impacted by estate taxes. The intent of the model is to show how changes in the estate tax and/or tax treatment of life insurance would change the accumulation of wealth by individuals. This modeling is important, as new estate tax reforms are likely given that the current reforms expire at the end of 2010.