Life insurance can be a valuable and versatile financial asset that may be able to help individuals and families deal with a variety of financial problems. One of life insurance’s biggest advantages is its flexibility.
Policies can provide benefits for a limited number of years or for life. Premium amounts can be large or small. Money may be put in or taken out if the policy holds cash value. Benefits may be received during life or paid to beneficiaries after death. When properly handled, cash value life insurance policy distributions can be income tax-free. Because of its great versatility and flexibility, life insurance can be used to meet a wide variety of financial needs.
Here are some of the areas in which life insurance may provide excellent value:
Estate Settlement Costs. Expenses can begin before death (such as medical and hospital expenses, nursing home expenses, physical therapy, and drug costs) and continue for several years (probate costs, funeral expenses, appraiser’s fees, legal and accounting expenses, real estate commissions and property management fees).
Payment of Outstanding Debts. When a spouse or parent dies owing money to others, those debts have to be repaid as part of the probate process. Credit card balances, secured and unsecured loans, judgments, and loan guarantees are some examples of the outstanding debts that must be dealt with after death. Life insurance death benefits may provide the cash needed to pay them.
Guardianship Funds. Sometimes a single parent responsible for raising children dies unexpectedly. This is an especially tragic situation because the children may have to move in with a guardian who accepts the responsibility for raising and educating them. If the goals and dreams the parent had for raising the children are to come true, the parent may need to provide the guardian with resources to raise the children. It is probably unrealistic to expect a guardian to use his/her personal funds to raise someone else’s children. The quality of life for the guardian’s own family could be compromised. Life insurance coverage on the parent may provide the funds the guardian needs to raise the children.
Specific Bequests. It is common for people to put provisions in their wills earmarking a specific dollar amount of their estate to loyal friends and family members. These bequests have to be paid in cash. Other estate assets won’t work. Life insurance death benefits may create the cash needed to pay these bequests.
Charitable Bequests. Sometimes people put provisions in their wills directing specific sums of money to charities and important causes. Transferring other property to the charity likely won’t work because the charity needs cash to do its work. If the estate doesn’t have enough cash, the executor will need to sell some assets (possibly at a loss) to create the amount needed.
Bolster Family Financial Strength. When a working parent dies, his or her income stops. The family’s cash flow may be significantly reduced and hardship may result. Life insurance may replace all or part of that lost income; it can be of crucial assistance to the remaining family members so they can pick up their lives and stay together.
Pay Off the Mortgage. If a mortgage is taken out to finance the purchase, a spouse or parent’s death may cause a foreclosure. If his or her income isn’t replaced, the family may be forced to move out. Life insurance may provide the funds to pay the mortgage installments and keep the family in their home.
Special Needs Children & Grandchildren. It is not unusual for one child in a family to have a life-changing condition, accident, illness, or disease. When this happens, parents can find themselves in a difficult position. They can care and provide for their special needs child while they are alive, but what happens after they die? Who will take care of their child and where will the money come from to provide the care? Is it fair to expect healthy children to divert time and money from their own families to do the job? Life insurance death benefits may provide extra dollars to secure a special needs child’s financial future without adversely impacting the other children.
Education and College Funding. The death of a parent sometimes cuts off money that was to be used to put children through college. Life insurance death benefits can help pay children’s education expenses if a parent dies early.
Equalize Inheritances Between Children. It is generally assumed that children will inherit their parent’s assets in equal shares—that the assets will be divided up and distributed in equal parts to the children. Unfortunately, sometimes, this isn’t possible. It may not make sense to divide a house, a business, or real estate into equal shares. The nature of the assets or the children’s personal situations may make equal division impossible. The only way to treat children equally when it’s unwise to divide assets into equal shares is to use cash to make up the difference. Most people don’t have large amounts of cash. Fortunately, life insurance death benefits may create the additional cash needed to make sure each child receives equal estate value, even if what they receive is different.
Ease Conflicts Between Children and a Second Spouse. When a parent with children remarries, there is great potential for conflict. The new spouse and children have different financial interests. After the parent’s death, the new spouse needs financial security but the children want their inheritance. If they have to wait until the new spouse dies, great animosity may develop between them. Life insurance on the parent may provide the financial security the new spouse needs and allow the children to receive their inheritance immediately. Conflict between the spouse and children may ease.
Federal & State Income Taxes. Income received in the year of death may be taxable and create a debt the estate must pay. Life insurance death benefits may create the cash the executor needs to pay these taxes.
Income In Respect of a Decedent (IRD). Many people die owning assets that have not yet been taxed but which will be. Some of these are called “IRD Assets”; they include IRA/qualified plan dollars in the decedent’s name, the growth element in variable annuities the decedent owned, and a decedent’s interest in a deferred compensation plan. When passed on to a beneficiary at death, these taxes become the beneficiary’s responsibility. Life insurance death benefits can provide liquidity to pay the federal and state income taxes due on IRD Assets. When used this way, life insurance death benefits may restore the full account balance to the person(s) entitled to receive it.
Property Taxes. Many states annually tax the value of real estate—whether used as a principal residence (homestead), seasonal residence (vacation home) or business. Property taxes due in the year of death are seldom forgiven. Instead, the estate is usually responsible for paying them as well as property taxes assessed in future years while the estate owns the real estate. Life insurance death benefits may provide the cash needed to pay these taxes.
Federal & State Estate and Inheritances Taxes. The federal government levies a tax on a person’s right to transfer his or her property to others after death. Although designed to apply only to those with relatively high net worths, this tax has one of the highest marginal rates in our tax system. Many states have a similar tax, either in the form of an estate tax payable by the estate or an inheritance tax that is paid by heirs who receive property from the estate. When the estate is large enough for these taxes to be assessed, the total cost can be quite high. Life insurance death benefits may provide the liquidity needed to pay these taxes.
Business Succession. In closely owned businesses, the voluntary or involuntary departure of an owner can cause big problems. If there is no succession plan in place, business operations may terminate. If there is a plan, it needs to be backed up by money so the departing owner’s interest can be purchased. Life insurance may be an efficient way to secure the dollars needed to keep the promises in the agreement.
Loss of a Key Employee. Every business has several key people whose talent, insight, and ability are the keys to making it profitable. The unexpected loss of a key person can be a financial disaster. Because key employees are so valuable, businesses must keep them as long as possible and find a way to replace their value if they die unexpectedly. Life insurance is frequently used to reimburse the business for the revenue and profits that can be lost with a key employee’s death. It can also provide funds to pay for locating, hiring, and training a qualified replacement.
Key Employee Selective Benefits. The challenge family-owned businesses have with non-family key employees is to keep them with the business and give them incentives to do their best. The family seldom wants to give them an ownership interest, so it needs to find financial incentives that recognize the key employee’s hard work and make it satisfying to continue. Bonus plans, non-qualified deferred compensation plans, phantom stock plans, and split-dollar arrangements may accomplish these goals. Life insurance policies are regularly used to fund these types of benefits.
Owner Employee Selective Benefits. Owners of closely owned businesses don’t need incentives to make the business profitable. The capital, time, and emotional energy they’ve invested in the business are incentive enough. They need additional ways for their business to secure and improve their personal net worths. Selective benefits can be very useful in helping them maximize the financial benefits they get from their hard work. As with non-family key employees, bonus plans, non-qualified deferred compensation plans, and split-dollar arrangements accomplish these goals. Life insurance is regularly used to fund these types of benefits.