Like all insurance, life insurance is meant to protect against the unexpected and manage the financial hardship that an event can create. Homeowner’s insurance protects you against the expenses of a fire. Auto insurance protects against the expense of an accident. Life insurance is meant to protect against the loss of income should death occur.
Are you currently working and if you were to die, would someone be harmed by losing your income or an increase in expenses? Are you still raising your children – the family would likely be harmed if your $75,000 paycheck disappeared overnight. As a stay-at-home parent, you may not be earning a paycheck; however, expenses might increase for daycare costs, for the remaining parent needing to reduce work hours, or the need to hire additional household help. As a retired individual, your spouse may need to replace your pension income if there are no survivor payments. There may be a concern about paying final expenses – burial costs, medical bills, etc.
One question we often get is what happens when someone passes away with debts or outstanding expenses? It becomes crucial to understand how an asset the deceased owns is registered. Only assets that belong to the estate are required to be used to pay outstanding debts. Life insurance death benefits, 401(k), IRAs, and other financial accounts often do not flow into the estate because a beneficiary is named on them. A house in multiple individuals’ names, say a married couple, would now belong to the remaining owner. This likely would mean the remaining owner is now responsible for the entire debt or could lose the house because it is collateral on the mortgage. Cars, personal possessions, possibly bank and investment accounts – assets without a named beneficiary or that are not joint with someone else would go into an estate.
The assets of the estate would then be available to pay final expenses or outstanding debts. Creating a dedicated burial fund account can make sure that funeral expenses are taken care of. Creditors cannot come after anyone other than the estate to pay outstanding debts unless someone else is joint on the debt. Credit cards in both spouses’ names mean payment would be required. Payment for a credit card in only the deceased person’s name is required to be paid by estate assets. A mortgage or car loan means the financial institution could repossess those assets and expect the difference to be paid by the estate.
I am not advocating leaving behind a lot of unpaid debt and outstanding expenses. Understand that you are often not leaving others to pay those debts or expenses if you are not here to pay them. If an individual is joint on the loan or has co-signed a loan, they will be personally held responsible for that debt. Only the estate and assets within the estate are required to be used to pay other debts and outstanding expenses.
This is where life insurance can be useful. Suppose I have a $100,000 mortgage on the house, and I know that my spouse cannot afford those payments without my income. In that case, I will want life insurance proceeds available to pay off that mortgage – and probably to help with the ongoing annual costs of homeownership such as taxes, utilities, and maintenance. Will there be a concern without my income of how to pay college costs for young children? I may want life insurance proceeds to fund college education funds. Without my paycheck coming in, will my spouse be able to provide the same standard of living for my children and himself or herself? If not, I might want life insurance proceeds that can help supplement the remaining income of the household.
If my paychecks were to stop tomorrow, would anyone be harmed by the lack of that income? Life insurance can be the solution to this concern.
As individuals retire, there is no paycheck coming in. Many live on Social Security, pensions, and investment income. If one spouse were to pass away, does the remaining spouse have enough income to maintain the standard of living with less Social Security benefits? When a pension payout began, was the choice made to continue the pension for the remaining spouse, or does the pension payment stop with the death? Are there anticipated to be enough funds tucked away in IRAs, 401(k)s, 403(b)s, annuities, and other investment accounts to cover the loss of Social Security or pension income at death? This death can create a potential cash flow shortfall. Receiving the death benefits from a life insurance policy can replace income if a shortfall exists when a person passes away.
If no one is dependent upon your income or can survive without your income, is there a reason to incur life insurance costs? Generally, the answer is no. Purchasing life insurance on a child can be inexpensive to start. What truly are the costs going to be of having that policy for the next 60, 70, or more years? Is there a way to get a bigger “bang for your buck” by doing something different with those funds? Does a single person with no children need life insurance? In most cases, not. There is no one dependent upon their income.
Sometimes there is a justification for obtaining the insurance now because of a concern about qualifying later. For children – if there are genetic concerns that bring in the question of qualifying for insurance later, it might make sense to purchase life insurance. A single individual anticipating a need in the future might consider purchasing a policy to ensure coverage for that need. A single individual who is financially supporting children or parents may need life insurance to replace that loss of income for those individuals.
The latest use of life insurance is to use it as an investment tool. If I am fully funding my employer’s retirement plan at work and fully funding my IRA, the right type of insurance can offer the ability to have an additional source of funds in retirement that can be tax-free. In this case, you are purchasing life insurance, not for a death benefit to replace income when you pass; you are purchasing life insurance to provide you with cash flow while you are alive. This can be a viable means of generating cash flow in retirement if you purchase the right type of policy and make withdrawals appropriately.
As we consider the impact of future taxes for those in higher tax brackets and for those with excess dollars to invest, funding a life insurance policy may be a good option to generate future cash flow. The funds are put in as premium dollars for a period of years – maybe for 10 years, maybe to age 65, whatever the policy is set up for. The goal is to put the maximum dollars in with a minimum death benefit. Having a minimum death benefit reduces the cost of the insurance throughout the life of the policy. Premiums paid grow inside the policy – and to get them to grow at a greater rate, you will need those dollars to either be market-invested or be using an indexed investment strategy. Once retirement occurs, you start withdrawing the funds under a loan provision. It is essential that the interest rate for borrowing funds is close to the interest rate the insurance company is paying in the loan accumulation account so that you have minimal or no net cost for borrowing these funds.
The funds have grown tax-free inside the policy while you are accumulating them. The cash that you are receiving comes out tax-free when you make sure that you do not take out too much in loans. Upon your death, the loan proceeds are taken out of the death benefit, with the net being sent to your named beneficiary.
For income replacement, purchasing life insurance for payment of final expenses, as an investment, can be a recommended use of funds if the correct type of insurance is purchased. Look for more on life insurance in the next few blog posts as we explain the types of insurance and recommended uses. And – of course, you are welcome to call us at Planning with Purpose if you want to discuss your personal situation and life insurance recommendations.