As the first step, watch our “10 Minute Lesson on Life Insurance”:
Life insurance is a unique asset. Because of its potential high yield and its tax-favored benefits, it can be used to solve some of life’s perplexing financial problems.
Death Benefit Uses for Life Insurance
- Create an estate: Where time or other circumstances have kept the estate owner from accumulating sufficient assets to care for his or her loved ones, life insurance can create an instant estate.
- Pay death taxes and other estate settlement costs: These costs can vary from a low of three to four percent to over 50 percent of the estate. Federal Estate Taxes are due nine months after death.
- Fund a business transfer: Business owners often agree to buy a deceased owner’s share from his or her estate after death. Life insurance provides the ready cash to finance the transaction.
- Pay off a home mortgage: Many people would like to pass the family residence to their spouse or children free of any mortgage. Often a decreasing term policy is used, which decreases in face amount as the mortgage balance is paid down.
- Protect a business from the loss of a key employee: Key employees are difficult to attract and retain. Their untimely death may cause a severe financial strain on the business.
- Replace a charitable gift: Gifts of appreciated assets to Charitable Remainder Trusts can provide income and estate tax benefits. Life insurance can be used to replace the value of the donated assets. Proceeds from life insurance policies can also be paid directly to a charity.
- Pay off loans: Personal or business loans can be paid off with insurance proceeds.
- Equalize inheritances: When the family business passes to children who are active in it, life insurance can give an equal amount to the other children.
- Accelerated death benefits: The Health Insurance Portability and Accountability Act of 1996 changed federal tax law to allow a “terminally ill” individual to receive the death benefits of a life insurance policy on his or her life, income tax free.’ Such “living benefits,” received prior to death, can allow a person to pay medical bills or other expenses, and maintain his or her dignity by not dying destitute. If certain conditions are met, a “chronically ill” person may also receive accelerated death benefits free of federal income tax.
Existing life insurance policies should be reviewed to verify that policy provisions allow for payment of such “accelerated death” benefits.
Other Uses for Life Insurance
While life insurance products are primarily used for death benefit protection, they are also commonly used for long-term accumulation goals.
- College fund for children or grandchildren: Cash value increases in a policy on a minor’s life (or the parent’s life) can be used to fund college expenses.
- Supplement retirement funds: Current insurance products provide competitive returns and are a prudent way of accumulating additional funds for retirement.
Available cash values may also serve as an “emergency reserve,” if needed, or a source of loans, since life policies frequently include features permitting borrowing against these cash values.
Considerations in the Purchase of Life Insurance
Who Will Be the Owner of the Policy?
Life insurance proceeds are included in the estate of a deceased if he or she has any incidents of ownership in the policy. Ownership by adult children or an irrevocable life insurance trust should be considered if there is an estate tax problem.
How Much Life Insurance?
This will depend on the need it is fulfilling. Amounts needed to fund a business transfer or to pay death taxes may be readily determined.
Calculating the value of a human life to a family is more difficult. A trained financial advisor can help in the determination of an appropriate amount.
What Type of Policy Should Be Purchased?
A person trained in life insurance can explain the many different policies available and assist in selecting the one which best fits your needs.
How Should the Premium Be Paid?
Sometimes the amount of the premium can be paid from current income, while other times it may be prudent to reposition other assets so as to be able to acquire sufficient insurance protection.
If the insured is a business owner or executive, a corporation may assist in paying premiums. Other times it may be better to have the corporation own the policy and use the proceeds to purchase part or all of the owner’s interest at death.
Insurance can also be purchased in certain qualified retirement plans.
