Let’s face it: most people are averse to life insurance. For permanent policies, the premiums are high, and the payouts typically don’t happen until you die. Couple that with the fact that many life insurance agents are overly aggressive, promising that life insurance will bring peace to the Middle East.
Still, I’ve noticed a few scenarios where life insurance makes sense. If you fall into one of these categories below, then you should talk with an estate planning attorney, because life insurance is best used as a component of an overall estate plan.
Reason #1: Term life insurance protects young families, and is pretty cheap.
While children are still young, the death of a parent can be financial crippling. This is especially true in today’s financial environment, where is typically takes two incomes to provide a quality upbringing for your children.
Thankfully, term life insurance can provide a high level of coverage for relatively cheap premiums. If you have young children, you absolutely must have term life insurance. It’s part of being a responsible parent.
Reason #2: Life insurance is a better alternative to long-term care insurance.
People ask me all the time whether they should get long-term care insurance. Here is what I tell them:
If you end up in a nursing home for an extended stay, long-term care insurance will be the best thing you ever bought. But if you don’t go into a nursing home, then you will have squandered tens, or even hundreds, of thousands of dollars for nothing.
A better alternative is to use permanent life insurance that allows for the acceleration of the death benefit to pay for long-term care expenses. Here’s how it works:
You purchase permanent life insurance with a death benefit of $300,000. You stay healthy until you die, and incur no long-term care expenses. Your family receives $300,000.
You purchase permanent life insurance with a death benefit of $300,000. Your health declines and you incur long-term care expenses of $200,000. The insurance company pays the long-term care expenses, but reduces the death benefit by that amount. When you die, your family receives the remaining $100,000.
Whether you remain healthy or not, you’re going to get $300,000 out of the insurance policy. This type of life insurance costs only slightly more than long-term care insurance, but it guarantees that you’ll get a return on your investment. It’s all of the benefit with none of the risk.
Reason #3: The tax advantages of life insurance increase the children’s inheritance.
When you invest money, and earn a return during your lifetime, you pay income taxes to your state and federal government. Then when you die, if your net worth is above certain thresholds, both Massachusetts and the IRS levy a tax on your estate. Even if your investments go through the roof, these taxes take a huge chunk of it, and your family winds up with much less.
Life insurance is treated differently than most investments. Even though you invest money into a life insurance policy, the death benefit is not considered taxable income. Further, when done correctly in trust, the death benefit is not subject to the estate tax.
The result of these tax advantages is that life insurance can provide a great return on investment for a very small amount of risk, especially for those in high tax brackets. This is a great strategy for families that can afford to invest in insurance without impacting their quality of life. If you can easily afford it, then you should do it.
Reason #4: Life insurance can protect a business and it’s owners.
Aside from its normal uses, life insurance is a component of several business planning strategies. The most common uses are to protect the business from the death of key employees, to fund a buy out of the company if one of the owners dies, and to equalize the inheritance of children that are not active in the business.
The first of these strategies is fairly simple. If one of the key employees of a business dies, then the business will likely suffer a financial loss. If the business maintains a life insurance policy on that employee, then the death benefit would offset the financial loss, and allow the business to continue during the transition period.
The second strategy is used when more than one partner owns a business. When one of the owners dies, the other owner will receive a life insurance death benefit, which is used to buy out the deceased owner’s share of the business. That way the decedent’s family receives cash, and the remaining owner keeps the business. You can read more about this strategy here.
The third strategy is useful in situations where the business is the family’s largest asset. Often times some children are active in the business, but others are not. In the ideal situation, the active children would inherit the business, and the non-active children would inherit other assets. If there aren’t enough other assets to equalize the shares, then life insurance can provide the liquidity needed to do so.
To recap, these life insurance strategies are geared towards: 1) young families, 2) those worried about future long-term care expenses, 3) families in high tax brackets that want to leave an inheritance, and 4) business owners. If you fit into any of these categories, then you may benefit from a closer analysis of your estate planning. Remember, while these strategies fit neatly into a blog post, it takes trusted professionals to implement them properly.