If you die tomorrow, who will be shouldered with your debts? Even if you have assets, your looming credit card debt, car loans, and mortgage probably won’t be enough, leaving your heirs with the burden of finding other ways to pay creditors.
It is becoming an ever-increasing issue among Americans aged 50 and over to carry additional debt. According to a report referenced in a 2013 Fox Business article, middle-income Americans nearing, or in, retirement now have more debt than younger Americans. In fact, the older group had an average of $8,278 on credit cards in 2012 compared to $6,258 for younger people. This is not only the reverse of 2008 trends, but doesn’t even include mortgages, loans, and other liabilities.
“We’ve seen situations where the kids were living above their means waiting for a parent to die to bail them out only to find that it won’t happen because the parents have debt,” said Martin Shenkman, an estate planner in Paramus, N.J. “In really bad situations, the disappointment has led to pretty significant antagonism among the heirs.”
So what should you do to prevent transferring your money-related stress and anxiety to your benefactors? Purchase life insurance. The following article will explain everything you need to know to you make the right decision. Know your options, costs, benefits, and myths before contacting your independent insurance agent.
Life insurance is a contract between you and your insurance company in which the insurer promises to pay your beneficiary a sum of money upon your death. This agreement is dependent upon your payment of a premium, either as a monthly or lump sum. It is a protection policy for your loved ones and is designed to benefit them if something tragic or unexpected were to occur.
It’s important to remember that you don’t need to be the person that is insured to take out the policy. You can purchase life insurance for your spouse, child, or parent. If you buy the policy for your loved one, you have the assurance of knowing that they are protected, and that the beneficiary of the policy will be able to pay for any expenses after the insured person dies.
Types of Life Insurance
There are two main types of life insurance: term and permanent coverage. Within each category of insurance, there are several sub-categories with different benefits, costs, and payment plans.
Term Life Insurance
This is the most basic form of life insurance. It is coverage in its simplest form. There are only three factors that need to be considered before purchasing this coverage:
- Face amount, or the amount of death benefit you’d like
- Length of coverage (or term); usually this is between one and thirty years
If you purchase term level coverage, it means that the death benefit will not increase or decrease during the period of the policy. However, choosing decreasing term insurance means that the death benefits drop each year of the coverage by specified increments. In 2003, over 97 percent of term life insurance was the level term option, and within this category, the most common policy length was twenty years.
Choosing term insurance with a renewable option means that you can choose to an additional term, usually until you reach a specified age. If you health has changed during the period of your policy, this would not automatically prevent you from being able to renew.
This type of life insurance is a bit more complicated. While it has the advantage of remaining in effect until you are deceased, it has a different premium payment plan and involves investments. Even after the policy reaches maturity, your coverage remains active, but you no longer have a monthly premium. While the coverage can’t be cancelled, unless done so within a legally defined period of time, the policy’s cash value increases over time.
A) Whole Life: The most common type of permanent life insurance, it provides you with a death benefit and savings account. Under this plan, your premiums and death benefit are specified in advance. However, the savings account builds cash value based on the investments the insurance company chooses. You can also borrow money against this cash value without paying any additional taxes.
Whole Life Insurance is a form of Permanent Life Insurance that provides a death benefit at normally a level premium for as long as you pay the premium. This kind of policy accumulates a cash value. The policyholder can access the cash value by withdrawing or borrowing. If the policyholder dies with a loan balanced owed, that amount will be subtracted from the death benefit paid to the beneficiary.
B) Universal Life: There are several differences between universal and whole life insurance. First, you can increase the death benefit, presuming that you are able to pass a medical examination. Once you reach a certain sum of money within the insurance savings account, you can lower your monthly premiums, assuming that the account will cover the rest. However, if you eliminate your savings, the policy may lapse, so be careful when choosing to lower your payments.
C) Variable Life: Similar to whole life insurance, it provides death protection and a savings account. However, you have the option of investing the account money on your own in stocks, bonds, and mutual funds. This is a riskier option, as you are at the mercy of poor-performing stocks, which would reduce the cash value and death benefit of the plan.
Life Insurance that accumulates a cash value on a tax-deferred basis. Operates somewhat like a mutual fund in that the insured pays premiums into an investment account that is owned by the insured. There is a death benefit, which is variable and depends on the performance of the insured’s investments. Variable life policies are securities. This is an extremely esoteric coverage that requires special licensing for an agent.
D) Variable-Universal Life: This is a combination of both the variable and universal life insurance policies. You can choose your own investments, while at the same time adjust you premiums and death benefit.
E) Limited Pay: Under this policy, you pay all of your premiums within a certain time period.After that, no additional premium payments are needed to continue the policy. While you can choose the length of the pay term (such as ten or twenty years), all of your payments need to be concluded by the time you reach 65 years old.
F) Endowments: This is the most expensive type of permanent life insurance, but it does have its advantages. With this policy, you choose an endowment age, meaning that the cash value and death benefit will become equal by the time you reach a specified age. The expenses arise from the fact that your premiums are higher (but paid over a shorter period of time). However, one you reach the endowment age, you can cash out the value and death benefits to your beneficiary, whether you are still living or not.
Important: Keep in mind that if you’d like to switch from a term to a permanent policy, you don’t have to provide any other evidence of your insurability (Contracts may vary on this.).
In order to avoid fraudulent claims or additional risks, insurance companies usually include exclusions to receiving death benefits and/or the cash value of the policy.
- Suicide clause: The policy becomes null and void if the insured commits suicide within a certain time frame after purchasing life insurance (usually two years).
- Misrepresentation: The policy can also be cancelled if the insured misrepresented themselves in any way. There is usually a two year contestability period in which the insurance company in which to request additional information on the insured and determine whether or not to issue the death benefits.
Costs vs. Benefits
If you are young, single, or in a lower economic bracket, you may find ways to avoid buying life insurance. In fact, over 30 percent of all U.S. households did not have coverage in 2010. This includes over 11 million households with children under 18. However, the fact of the matter remains that your death could place an undue burden on your loved ones. According to Tony Steuer, author of The Life Insurance Toolbox, “ “You can’t predict the future. You don’t necessarily know how many kids you’re going to end up with, or even if you are going to get married.” So, consider the costs first, before avoiding insurance all together.
For term insurance, several factors are taken into consideration when determining premium costs including age and health at the beginning of the policy. The premium would remain the same for the length of the term and not increase unless you chose to renew your policy.
For teacher Danny Kofke and his wife, a term policy was the best option. They knew they wanted to have children, and it had a less-expensive payment plan. “The couple’s 10-year term life insurance policy covered them for $250,000 each, which equated to a $24.50 monthly fee per person. ‘It gave us both peace of mind,’ Danny Kofke says. ‘We treated it like having automobile insurance. I never want to have to use it, but it’s comforting to have it there.’”
For both term and permanent insurance, other factors besides health and age include:
- Medical history (of self and family)
- History of smoking
- Current medications
- Travel history
The insurance company takes each of these variables into consideration when determining your premium.
While you may find excuses to avoid paying for life insurance, take the time to reconsider, as there are many benefits. The following chart displays the main advantages, based on the category of life insurance.
Each type of life insurance has a death benefit and tax advantages. Other benefits include the following:
- Income replacement for dependents. If you have a spouse and young children when you die, this will help your family to face their new financial reality with confidence.
- Pay final expenses. Funeral and burial costs can be expensive, and there may be additional fees associated with the deceased, such as estate administration and final medical bills.
- Pay federal and state death taxes. This will enable your heirs to pay these fees without liquidating other assets.
- Contribute to charitable organizations. If you name a charity as your beneficiary, you will be able to give more than if you were to donate the cash equivalent of the policy.
- Create an additional savings account. If you were to fall on hard financial times, you would be able to borrow or withdraw from your insurance account.
While most families can rely on Social Security for post-death income, it is still recommended that you purchase life insurance for the additional financial stability and benefits. Consider the example provided by the Insurance Information Institute:
“Suppose a surviving spouse didn’t work and had two children, ages 4 and 1, in her care. Suppose her deceased husband earned $36,000 at death and was covered by Social Security but had no other death benefits or life insurance. Assume the surviving spouse is 36.
Assume that the deceased spent $6,000 from income on his own living expenses and the cost of working. Assume, for simplicity, that the deceased performed services for the family (such as property maintenance, income tax and other financial management, and occasional child care) for which the survivors will need to pay $6,000 per year. Assume that the survivors will have to buy health insurance to replace the coverage the deceased had at work, and that this will cost $12,000 per year.
Taken together, the survivors will need to replace the equivalent of $48,000 of income, adjusted each year for an assumed 4 percent inflation.
Thanks to Social Security, the survivors would need life insurance to replace only about $1,700 per month of lost wage income (adjusted for inflation) for 14 years until the older child reaches 18; Social Security would provide the rest. The survivors would need life insurance to replace about $2,100 per month (adjusted for inflation) for three more years when the non-working surviving spouse has only one child under 18 in her care.
The life insurance amount needed today to provide the $1,700 and $2,100 monthly amounts is roughly $360,000. Adding $15,000 for funeral and other final expenses brings the minimum life insurance needed for the example to $375,000.”
There are a lot of myths which can distort the realities of purchasing the right life insurance policy. Consider some myths listed by Investopedia:
1) Single persons without dependents don’t need life insurance.
If you die, someone will still be shouldered with the responsibility of paying your bills, whether it be your family or executor.
2) Life insurance policies only need to be twice your annual salary.
Consider all the debts that you would leave if you died, in additional to funeral bills. More than likely, this is much higher than twice your annual salary. Conduct a cash flow analysis to determine the amount of coverage you actually need.
3) Your employer’s term life insurance policy is enough coverage.
If you have a spouse and/or children, the company policy may not be enough.
4) Only breadwinners need life insurance.
Consider the costs you save with the services provided by the homemaker. Providing the homemaker with life insurance would subsidize against daycare and any other added expenses.
5) It’s better to invest your money than buy any life insurance.
Especially if you have dependents, it can be very risky to depend solely on your investments. After those assets are depleted, your dependents would have nothing left.
There are a lot of misunderstandings about life insurance. Hopefully, this article has helped to clarify some of those questions. If you are still unsure which policy is right for you, contact your individual insurance agent today.
Group vs Individual Life Insurance
Is it better to have a group life insurance policy through your work or an individual policy? It depends, “How insurable are you?”
Life Insurance is popular because it is used in so many different ways including:
Life insurance is largely used to provide an employee benefit. It is quite common for companies to provide two times the annual salary of their employees as a death benefit paid to a beneficiary designated by the employee.
Funding a buy/sell agreement is one of the most popular business uses. Most businesses have liquidity problems if one of the principals die at an unexpected time. By using the death benefit to satisfy the terms of the buy/sell between partners or shareholders, the corporation easily gets through what could be a challenging time.
Secure a Line of Credit
Banks are able to use the assets in an insurance policy to secure a loan.
Life insurance is often used to cover long-term debt that might severely impair a business’ ability to continue in the event of death to a principal.
Protect a Business from Loss
Many businesses identify their key personnel and buy life insurance on them naming the corporation as the beneficiary. This allows the business to protect themselves from the huge expense of replacing/training new personnel in the event of untimely death.
Smooth Financial Crisis
Years ago we became friends with millionaire philanthropist/columnist Percy Ross. Metropolitan sponsored his column, which is how we got to know him. Percy spoke in his book “Ask for the Moon and Get It” of meeting business money problems by using the cash values he had built in his Life Insurance policy. That was his emotional tie to Metropolitan Life. Many businesses use the policies as a way to avoid paying taxes on income for a few years, borrowing against the policy when cash is needed. That income becomes taxable if the policy is allowed to lapse.
Burial / Funeral / Senior Life / Final Expense Insurance
According to the National Funeral Directors Association the average funeral in the United States in 2012 cost $7,045 ($8,343 with a vault). Although this cost can be reduced through cremation (43.2% of funerals in the United States involved cremation) most families would find funeral expense to be a large financial burden. Many people pre-plan their funeral and fund the expense through a Life Insurance policy listing the funeral director as beneficiary.
Pay for College
Many parents and grandparents fund college for their children and grandchildren through Life Insurance. They use the policy as a savings device to meet the high cost of college. According to College Data, the average expense for a year of college (moderate budget) at a state school was $22,261 for 2012. The average cost for a private college (moderate budget) was $43,289 in 2012.
Pay Mortgages and Debts
One of the primary purposes of Life Insurance is to leave a “clean slate” behind when you die so that your loved ones are not burdened. Life Insurance is often used to payoff credit card debt, mortgage balances, bank loans, student loans, car loans and other personal debts. Some use Credit Life insurance for this, which is term life that names the lender as the beneficiary.
Guarantee Future Insurability
Because Life Insurance is used in so many ways, being able to buy it in larger amounts is often a necessary part of financial planning. Many policies are sold to people at a younger age that allow them to increase the death benefit at certain intervals throughout their life without having to meet underwriting requirements. This protects them if they acquire a physical condition that would otherwise prevent the purchase of the needed Life Insurance.
Pay Estate Taxes
Many people find that Estate Taxes force them to sell the business or farm that their parents tried to pass along to them through their will. These often untimely or unwanted sales can be avoided through proper planning by using Life Insurance.
Long Term Care Rider
Given the high cost of long-term care many people are using Life Insurance to fund that expense. MetLife estimates the monthly cost of an assisted living community to have been $3,550 in 2012. Many people would rather create cash value that would be in their policy if they don’t use the Long Term Care expense feature. By adding a Long-Term Care rider to their whole policy they feel they have taken care of their Life Insurance needs and Long-Term Care Insurance needs in one policy.
Give Money to Charity
In 2001 I and two other people noticed our local school district struggling under budget problems. This had been going on for some time. With the help of many people we created a non-profit to generate supplemental funding for our school district. I was the first president. Over the last dozen years it has provided about $5 million in charitable giving to our school district to bridge the gap between what was needed and the funding they had available.
During that process I learned how many people name charities as beneficiaries for part of the death benefit from their Life Insurance. Many people consider it a “painless” way to donate to their favorite charities.
Create an Estate
My grandmother annoyed me as a child by telling me how much money recently departed people had left their families. To my young psyche it seemed terribly materialistic to value your self worth by the amount of money you left to your family.
As I’ve aged I’ve realized that her concerns were a product of when she was born, in the late 1800’s, more than anything else.
Many people find comfort in creating a financial plan that allows them to leave an estate. Life Insurance can create an estate far in advance of when a person could accumulate such a level of wealth.
Equalize an Inheritance
My parents died days apart. My father died from a heart attack and my mother, who had been healthy, died unexpectedly from heart failure, as well. I took this as a cruel injustice, especially so when I looked down during my mother’s funeral and noted that I was standing on my father’s new grave.
Later my attorney told me that he had noticed a large number of instances of spouses dying within days of each other.
Harvard did a study involving over a million people that showed Broken Heart Syndrome is a real phenomenon especially in couples who had lived together for a long time.
Luckily, my five siblings and I resolved the estate quite amicably. I’ve seen many instances where this wasn’t the case. This is especially so when both parents die in close proximity. People grieve in different ways and arguing over estates seems to be a favorite. Without a parent to intervene, the family dynamics become quite liquid and aberrant behavior becomes the norm.
While cash from a death benefit can’t solve who will receive your mother’s favorite broach, it can be handy to smooth over the strictly financial aspects of a will.
Provide Income / Annuities
Many people use annuities, a form of Life Insurance, to provide an income flow after they retire. They also use the death benefit from Life Insurance to provide income for survivors.
Smooth Financial Crisis
Just like using Life Insurance for your business to smooth cash flow, people use the cash value built up in their Life Insurance to solve personal financial crisis.
No Exam Life Insurance
Could late night cable television exist without Life Insurance that doesn’t require a physical to determine eligibility? People buy No Exam Life Insurance because they want the insurance really fast, they hate medical examinations, or they have a health condition that they think will prevent them from passing a medical examination.
Insurance companies have big beautiful home offices because they have actuaries who use mortality tables in the favor of the company to create large profits. They are not stupid. The money you will pay for No Exam Life Insurance will be significantly more than what you would pay, in most instances, for insurance through traditional channels.
It has its place, but beware, it is not a charity program.
Cash Value Life Insurance
A kind of Life Insurance that features a death benefit, and also accumulates cash value. Whole Life, Variable Life and Universal Life are kinds of Cash Value Life Insurance. Cash-value insurance is also known as Permanent Life Insurance because it provides coverage for the policyholder’s entire life.
Bank Owned Life Insurance
Bank-Owned Life Insurance is similar to corporate-owned life insurance, with the only major difference being that a bank, instead of a corporation, owns bank-owned life insurance.