Is there really a need for life insurance? The answer is....it depends. Listed below are twelve specific situations where a life insurance policy can be a viable solution.
Income Replacement – If you have financial responsibilities such as raising a family or have other dependents, you need life insurance to replace your income should you die prematurely (such as before retiring). Coverage amounts generally should be between 8 to 12 times your annual income, however the amount of assets or liabilities you have can change those numbers. "Level Term" life insurance policies will give you the most coverage for your money, and can even cover you until you reach retirement.
Cover Personal Debt Obligations – Should you have a mortgage, student loan debt, or are hoping to completely fund a college education for your child even if you were to pass away, life insurance is a must. The policy death benefit can used to pay off any existing (or future) mortgage or college expense.
Bank Loan Collateral – If you are looking to attain a loan from a bank, having a life insurance policy in place will ensure the bank that they will be paid back even if you die before the loan is fully repaid. This can help you to be looked upon as a “lower risk” candidate from the bank’s point of view.
Business Buy-Sell Agreements – If you have a business that has multiple partners, a well written Buy-Sell Agreement is a must have in order to ensure a smooth transition should any of the partners die before retiring. Funding the Buy-Sell with a life insurance policy will provide the funds needed to buy-out those shares that would otherwise end up with the former partner’s spouse &/or beneficiaries.
Business Key Person Coverage – As a business owner, you probably have what’s called a “Rainmaker” in your company. Someone who is responsible for producing the lion’s share of the company’s revenue. If this person were to die prematurely (aka before retiring), what would happen to your business? Purchasing a "Level Term" life policy on this “Key Person” will cover your business should such a disaster occur, as well as cover the cost of hiring and training a suitable replacement.
Funding a Special Needs Trust - If you are a caregiver to a relative that has special needs, a life insurance policy can provide money to continue to fund that care should you pass away.
Pay Estate Taxes Due Upon Death – For families that are “asset rich but cash poor”, proceeds from a life insurance policy can be used to pay any State and/or Federal estate taxes that would be due upon death. Purchasing either a "Guaranteed-No-Lapse" Universal Life (GUL) policy if single, or a "Second-to-Die" / "Survivorship" Guaranteed Universal Life (SGUL) policy if married, that's held in an irrevocable life insurance trust (ILIT) would be your best option.
Inheritance Equalization Strategy – If you own a family business and have some children that work in the business and others that don’t, leaving an inheritance that’s equal for all of them may be difficult. The solution would be to purchase a permanent life insurance policy on yourself, and have the non-business working children be beneficiaries. The policy can be for an amount that you consider equal to the inheritance of business ownership that the business-working children would receive. A "Guaranteed-No-Lapse" Universal Life (GUL) policy (permanent insurance without a cash-value feature) is an affordable option.
Pension Maximization Strategy – For participants in a Defined Benefit plan (traditional pension), your plan is designed to provide you with monthly income payments upon retirement. In a DB plan, your employer will give you two options that require an irrevocable choice on how the benefits will be paid—"Life Only" or "Joint & Survivor". The Life Only option pays you the maximum benefit, but upon your death, your spouse does not continue to receive payments. The Joint & Survivor option pays a reduced benefit (30-50% less), but your spouse will continue to receive benefits when you die. The pension max strategy uses life insurance to be a compromise between the two options. It allows you to receive the higher pension benefit (Life Only), while also providing funds for your spouse upon your death in the form of a tax-free life insurance death benefit. Ideally, you should be within five years of retirement when deciding on this strategy. It’s also important to note that depending on your specific pension plan, selecting the Life Only option may disqualify your spouse from medical benefits that would otherwise be available with the Joint & Survivor option. So be sure to carefully review your pension plan guidelines before making any decision.
IRA Maximization Strategy – For individuals that have significant assets and have an IRA that they won’t be tapping into during retirement, an estate tax issue may be of concern. A solution to that tax issue would be purchasing a Single Premium Immediate Annuity (SPIA) in the IRA using the current IRA money, and then using the after-tax SPIA payments to fund gifts to a type of ILIT called a “Wealth Replacement Trust”. These payments will then pay for a permanent life insurance policy (ideally a Guaranteed-No-Lapse Universal Life policy) in the trust that’s equal to the original value of the IRA. Upon your death the remaining SPIA assets will go to the annuity company, and the trust held life insurance death benefit will provide your heirs with a tax-free inheritance that would be several times larger than they otherwise would of received had the IRA been taxed. Also, you will no longer have to worry about making sure you have correctly computed and taken your RMDs each year after turning age 70½, as the SPIA will be making immediate payments.
Annuity Wealth Transfer Strategy – Individuals or couples who own a deferred annuity intended as a gift for their children, may be disappointed when they find out how substantial the tax burden is when an estate is large enough to be subject to the federal estate tax. A solution to this tax issue could be to convert the deferred annuity into a single premium immediate annuity (SPIA). After a tax-free “1035 Exchange” of the non-qualified deferred annuity into a SPIA, the annuitant uses the after-tax SPIA payments to pay for the purchase of a permanent life insurance policy. The life policy would be kept in and owned by an irrevocable life insurance trust (ILIT); the insurance trust would also be the beneficiary. The ILIT would be set up for the benefit of the children, resulting in a larger tax-free inheritance for them.
Charity and Replacing Wealth – In some cases a charitable donor would like to benefit his or her favorite charity, but does not want to disinherit their family by the amount of the donated gift. To resolve this problem, the donor must replace the property that was gifted to the charity. A life insurance policy can be a viable solution. The donor purchases a permanent life insurance policy equal to the value of the property gifted to the charity. Then, working with an estate attorney, the donor establishes an irrevocable life insurance trust (ILIT) called a "Wealth Replacement Trust" that will own the life insurance at the time of issuance. The wealth trust holds the life insurance, which will be out of the donor’s taxable estate, and can be set up for the benefit of the children, leaving them a tax-free inheritance. In the end the charity still receives its donations, and the donor’s beneficiaries will be guaranteed an inheritance.
Best Types of Life Insurance
Level Term Life Insurance – Term life is pure protection only, and will give you the most coverage for your dollar. Level Term coverage durations typically come in 5-year increments in the ranges of: 10, 15, 20, 25, 30, and now 35, and 40 years. Some insurance companies offer Level Term policies that have durations in 1-year increments, which range from 15 through 30 years. An example would be if your specific need finds a 15 year Term to be too short and a 20 year Term to be too long, then you can opt for a 17 or 18 year Term policy instead.
Guaranteed-No-Lapse Universal Life (GUL) – These policies are designed to function as a permanent term policy, meaning there is no expiration of coverage all the while building little to no cash value. The level premiums are specifically designed to fund the policy exactly enough to keep it in force and never lapse. Premiums and coverage duration range from age 95 to 121. While the "guaranteed lifetime coverage" option of these policies result in a cost of between 2½ to 3½ times more than a standard Term insurance policy, they are still half the cost of a typical whole life cash value policy.
Second-to-Die Universal Life (aka Survivorship UL) – These policies are best utilized when two spouses have an estate tax issue. For high net worth married couples, any estate tax is due upon the death of the second spouse. This type of policy matches that specific need by paying out its death benefit when the second spouse dies and estate taxes are due. While these policies do have a cash value component, you can reduce the premiums to a certain level to where there will be minimal cash value accumulation, and the policy will not lapse. Many of today's more recent Second-to-Die UL policies include a “no-lapse” feature.
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*This blog is strictly the opinion of Michael A. Malleo and not those of
ASH Brokerage Corp., nor any of our affiliates.
Malleo Financial Services LLC cannot and will not give any specific tax or legal advice.
Please consult your tax professional or legal professional for such advice.