When purchasing a life insurance policy, one of the primary decisions to be made is how much money will be paid out upon the death of the insured, as well as to whom those funds will be paid.
Most people obtain life insurance for the purpose of providing financial security to loved ones and dependents so that spouses or partners, children, business associates, or others who count on them for some type of financial support are not left struggling. With this in mind, it is essential to come up with the proper amount of life insurance needs.
Current and Future Anticipated Needs
In most cases, people do not know exactly when they will need their life insurance policy. That is why it is important to determine both current and anticipated future financial needs of survivors.
Needs can be calculated by coming up with the following key information:
- How much will be needed at death in order to meet immediate obligations? In this case, all final expenses should be accounted for such as funeral costs, the cost of burial, and any potential uncovered medical bills that may need to be paid. In addition, there will also likely be estate settling costs, outstanding debts such as personal loans and credit card balances, and an amount of unpaid mortgage balance. In addition, many individuals also want to account for future expenses such as the cost of their children’s college education.
- How much future income will be needed to sustain the household of the survivors? This number can be determined by calculating the present value of cash flow streams that survivors will need after the insured’s death.
While many of these numbers may only be approximations, it is still better than simply guessing at how much life insurance is needed, as this could leave survivors with far less than they actually require.
If the number that is arrived at seems high, the best route may be to purchase term life insurance to provide some or all of the coverage that is needed. This type of insurance is typically the least costly, and can allow insureds to purchase a large amount of death benefit at a very affordable premium price.
Saving for College Expenses
It’s no secret that college is more expensive than ever today. Many parents start saving for future college expenses when their children are small, in hopes of having enough for tuition by the time they reach college age.
Using life insurance can help to keep the promise that a child can attend a higher education institution – even if a parent is no longer there. By having a life insurance policy in place, the proceeds can be earmarked for a child’s college expenses – ensuring that tuition bills can be paid without the need for student loan debt in the future.
Life Changing Events
Life insurance should be considered any time there is any type of life changing event that occurs. And, those who already have life insurance coverage should review their policy
during these times in order ensure that their coverage is still adequate in light of the new changes taking place in their lives.
What are life changing events? These can be deemed as various milestones, both happy and sad, including events such as graduating from college and getting a first real job, getting married, and starting a family. Life changing events may also include a job loss, divorce, or the death of a spouse or loved one.
One of the biggest life changes that people go through is when they leave the world of employment and step into retirement. Life insurance proceeds are often used as income replacement for a surviving spouse. This is especially the case if the income stream from a company pension will cease upon the death of one individual, leaving the other spouse without a significant portion of their incoming cash flow to pay for everyday living expenses.
Planning for a Special Needs Loved One
When children grow older, not all parents become “empty nesters.” There are some parents who may never see their child become fully self supporting. These are the parents of those who are developmentally or chronically disabled – and most of these parents live
in fear of the day that their children survive them and face an uncertain future without their care and protection.
The physical, emotional, and financial costs of raising a disabled child – as well as care throughout adulthood – can be staggering. Depending on the type of disability, and the severity, the expense can vary a great deal. In some instances the cost can exceed $1 million or more.
Oftentimes, children who are disabled may qualify for government benefits. However, it is important to find that fine line between gifting or providing funds in other ways to supplement such funds, as doing so could jeopardize these benefits. Likewise, if parents have “too much” in savings, they may also disqualify their child for government assistance.
Setting up a special needs trust can provide a good way to benefit a disabled child without jeopardizing his or her other incoming benefits. In fact, the trust may even be set up to work in conjunction with certain government provided benefits such as Medicaid or Supplemental Security Income – and one way to fund such a trust could be through life insurance.
Doing so could ensure that there will be enough money to pay for the child’s needs over the long term time horizon. It can also be set up in such a way that it keeps the parent’s estate intact for other family members.
Reducing Estate Taxes
Throughout life, people are taxed on a variety of transactions – including income, purchases, sales, and even death. And, although life insurance death benefit proceeds are free from income taxation, they are included in a decedent’s overall estate as long as the insured is also the owner of the life insurance policy.
Therefore, unless specific steps have been taken to remove a life insurance policy from an individual’s ownership, th
e amount of a policy’s death benefit will be included in his or her taxable estate and will be included in the amount to be taxed.
In taking steps to remove life insurance from one’s estate, the policy proceeds can also then be used for actually paying the estate taxes that are due – without, however, being taxed as a part of the overall estate.
One of the key ways to remove life insurance policy proceeds from an insured’s estate is to set up an irrevocable life insurance trust, or ILIT, that will instead become the owner of the life insurance policy.
This trust will be irrevocable, meaning that the insured generally will not be able to change the terms of the trust once it has been signed. In addition, another individual must also be selected as the trustee of the ILIT.
Likewise, the insured also cannot be the beneficiary of the trust. However, his or her children can be – and they oftentimes are. Also, the ILIT cannot be made payable to the insured’s estate or to his or her revocable living trust (if applicable), as the insured’s ability during his or her lifetime to change their will or trust will also then result in the ability to change the beneficial enjoyment of the life insurance policy’s proceeds – in turn, bringing the policy back into the estate.
Determining How Much Coverage Is Needed
Before applying for life insurance, it is also essential to know how much coverage is needed. This is because having too little coverage can be detrimental to survivors. Yet, having too much coverage can also cause an individual to pay too much in unnecessary premium.
Therefore, narrowing down approximately how much life insurance is needed is essential. This can be done by using a life insurance needs analysis. Needs can be determined by answering several questions, including:
How much annual income would be needed by your family if something suddenly happened to you? ____________
How much income is currently available to your family from other sources? ____________
How many years would income need to be replaced? ____________
How much money would be needed for funeral and other final expenses? __________
How much would be needed to pay off your mortgage and other debts? ____________
How much would be needed for future college expenses? __________
How much would be needed for daily living expenses? __________