One-third of U.S. adults have no life insurance, according to recent research. That may not actually be such a big deal. Not everyone needs life insurance.
What’s truly alarming is a finding that most people who already have life insurance may not have enough coverage to help prevent the financial hardships that many families face when a major breadwinner dies unexpectedly.
The uninsured families are probably aware that they lack coverage. It’s the underinsured families who run the risk of finding out too late that they didn’t have enough insurance.
Most adults only have group coverage through an employer. Although life insurance is a valuable employee benefit, the risk here is that you could be lulled into believing that having some life insurance is the same as having the appropriate life insurance coverage for your situation.
This life insurance primer may help you understand why and how to obtain life insurance coverage that suits your family’s needs.
How Much Coverage Do You Need?
Experts recommend a variety of methods to estimate how much life insurance your family might need, but the best method might be a good old-fashioned gut check. Ask yourself some tough questions about how much money the family would need if a breadwinner in the family suddenly died:
- How much money would the surviving spouse need to pay the mortgage and avoid having to sell the family home and move to a smaller residence?
- How would the surviving spouse care for the children if he or she needed to work?
- How will the kids pay for college?
- How will the surviving spouse’s retirement program be affected? Will he or she be able to continue setting aside enough money to fund a comfortable retirement?
Once you have the appropriate coverage in place, it’s wise to review your policy (or policies) on a regular basis. Here are some of the things you will want to review:
- Have there been changes in the family that would affect the level of coverage?
- Has the mortgage payment gone up (or down)?
- Has the wage earner’s salary increased significantly since the policy was purchased? Has the family’s need for income increased since the policy was purchased?
- How has inflation reduced the spending power of the death benefit from a policy that may have been purchased several years ago?
- Are the primary and secondary beneficiaries properly designated on the policy?
What Type of Policy Do You Need?
Most life insurance policies fall into one of two categories. Term life insurance is a temporary policy that remains in force for a set number of years. If the policy expires before you do, your heirs receive nothing upon your death. This type of policy does not accumulate cash value, and the insurance company keeps all premiums you paid during the term.
Term insurance is a popular choice for young families because it can offer a substantial death benefit at a fairly reasonable cost. However, term policies become more expensive as the insured ages and may eventually become costly to renew.
Cash-value life insurance, also called permanent insurance, typically remains in force throughout your lifetime, as long as premiums are kept current. When you buy a permanent life insurance policy and begin paying the premiums, the policy has the potential to accumulate cash value on a tax-deferred basis. Eventually, you may be able to withdraw any cash value up to your cost basis in the policy, which is the amount of premiums paid, without incurring any income tax liability.
When your cost basis has been withdrawn, you may be able to borrow against the death benefit. Because loans are usually not considered to be income, you typically will not incur any income tax liability. However, the amount of any outstanding loans plus any interest will be deducted from the death benefit after the insured has died.
Permanent insurance may seem like the easy choice, but it is usually more expensive than term insurance. This type of policy is popular among people who expect to owe estate taxes or want to leave a legacy for their heirs and/or a charitable cause. A permanent life insurance policy is also appropriate for people who are attracted to the idea of potential access to the accumulated cash value during their lifetimes for retirement income, college funding, or other major financial goals.
Will Your Family Have to Pay Taxes on the Life Insurance Benefits?
Your beneficiaries will not owe income taxes on the death benefit from your life insurance policy, but if you own your life insurance policy anytime during the three years prior to your death, the death benefit will be considered part of your estate and could contribute to a potential estate tax liability.
If you don’t believe your estate will be subject to estate taxes, here are two possibilities that you should consider:
- A large death benefit could raise the value of your estate high enough to trigger estate taxes.
- Don’t discount the possibility that your estate could grow large enough during your lifetime to trigger estate taxes upon your death.
By setting up a properly structured irrevocable life insurance trust to own your life insurance policy, the death benefit will not be considered part of your estate. You fund the trust by making “present interest gifts” of cash each year to the trust, which uses the money to pay the premiums. The use of trusts involves a complex web of tax rules and regulations. You should consider the counsel of an experienced estate planning professional before implementing such strategies.
Purchasing the appropriate type of policy and amount of coverage involves many factors, some more complex than others. Please call if you would like to review the role that life insurance can play in your financial situation.
The cost and availability of life insurance depends on age, health, and the type and amount of insurance purchased. Before implementing a strategy involving life insurance, it would be prudent to make sure that you are insurable. As with most financial decisions, there are expenses associated with the purchase of life insurance. Policies commonly have mortality and expense charges. In addition, if a policy is surrendered prematurely, there may be surrender charges and income tax implications.
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