As a Certified Financial Planner® with over two decades of experience, I’ve helped clients navigate the complicated world of life insurance and secure the appropriate coverage for their situation.
Here are the top seven reasons to own life insurance:
Family income protection
Losing a spouse and the parent of your children is devastating. And after the funeral ends, the financial disaster begins. Here are some of the financial impacts of losing a spouse:
- Lost income for the survivor. Most widows and widowers need some time off to grieve and re-orient their lives.
- Lost income from the person who died.
- Extra childcare expenses without a spouse to share childcare duties.
- Potential relocation to be closer to family support.
- Lost opportunity to build savings for retirement and college educations.
Life insurance can never replace a lost spouse, but it can prevent financial disaster.
Pay off a mortgage
It’s increasingly difficult to qualify for and make payments on a mortgage without two incomes. Survivors can use life insurance proceeds to pay off a mortgage, or at least to continue making mortgage payments.
Pay for your children’s education
In 2021, the national average cost of attending a public university and living on campus is $26,820 per year. Life insurance is no substitute for saving for college – the goal is to be able to fund college without dying. But if you’re not around to add to the college fund, life insurance can fill the gap.
Pay off business debts
You may have borrowed money to purchase rental properties or a local business. Your survivors can use life insurance to retire the debt and make a decision about whether to keep or sell business assets without selling under pressure to pay the bills.
Fund a Buy-Sell Agreement with a business partner
Business partners have complicated relationships. They share ownership in a business and also responsibility for running it. When your business partner dies, you’ve got to figure out how to keep the employees paid and the lights on when a big piece of the puzzle is missing. Whether your business partner focused on sales or operations, you’ve got a hole to fill. Their surviving spouse now owns part of the business but may have no interest in or talent for running it. And yet that business ownership may be one of the surviving spouse’s largest assets.
Most of the issues can be resolved with a well-crafted Buy-Sell Agreement funded with life insurance. A Buy-Sell agreement can cover the death or disability of a business owner, or even be a guide to an orderly breakup of a business partnership. Most commonly, the Buy-Sell Agreement outlines the responsibilities of the remaining business owner to purchase the dead or disabled business owner’s share from his surviving family. This gives the remaining business owner control of the business, and gives the departed business owner’s family a cash payout for their share of the business.
There are two crucial elements to making a buy-sell agreement work. First, the business should be regularly valued and there should be predetermined mechanism for calculating the value of the business if the Buy-Sell Agreement is triggered. Second, the business owners need to own life insurance on each other to provide the cash purchase the remaining interest.
Accumulate tax-free savings for retirement
There are three primary ways to design a life insurance policy:
- Term coverage with premiums that stay level for a fixed period of time. You’ll get the most life insurance for the least amount of money because most policies expire without every paying a death benefit.
- Permanent insurance that will be in place for the rest of your life. Though there are many different flavors (whole life, universal life, variable universal life, indexed universal life, etc.) the main feature is that you pay premiums until you die in exchange for a known death benefit now or later. The premiums are much higher than for term insurance because the insurance company must fund that death benefit some day in the future. Most permanent policies build up cash value over time, but to keep the policies affordable they are designed to have the lowest premium possible keep the death benefit intact. Growth of cash values is a secondary consideration.
- Life Insurance Retirement Plans, or LIRPs. With a LIRP, the policy is designed to accumulate cash value quickly, with the death benefit as a secondary consideration. This policy design is the opposite of most permanent policies. The question isn’t how much death benefit you can buy for your premium dollar. In this case, you’ll accept the lowest legal death benefit allowable for the premium dollars you are paying. Why? Because cash values accumulate tax-free inside of the policy. Your premiums can be withdrawn tax-free at any time. Any growth in cash values beyond premiums paid can be borrowed against tax-free in the future. LIRPs are most-commonly used by high income earners who have already maxed out their 401k plans at work and want to save more on a tax-advantaged basis. One benefit of LIRPs is that cash values can be accessed tax-free before age 59 ½ so they work well for early retirees. These policies have a lot of moving parts and need to be managed carefully to avoid letting the policy lapse and having withdrawn investment earnings become taxable. You’ll also want to have other life insurance in place for traditional family income protection. For more info on our life insurance services, click here.
Fund a charitable bequest
Let’s say you have a dream to leave $100,000 to your favorite charity. You don’t have the money now, but you do have disposable income. You can purchase a life insurance policy and name the charity as the beneficiary. You’ll probably want to own a permanent policy (whole life or universal life) since the goal is to provide a specific bequest at your death – even if that death is decades away. You can also make a charity the partial or contingent beneficiary on an existing policy. One could make the argument that leaving your IRA to charity is a better strategy – charities don’t pay taxes on a taxable IRA but your heirs will, and life insurance proceeds are tax-free. But if you don’t have an IRA or other assets to leave to charity, life insurance is a reasonable choice.
Fund a special needs trust for your child or grandchild
Families who have a special needs child need to plan for two generations. It’s not enough to make sure you have enough for retirement. You need to make sure that your special needs child or grandchild will be well taken care of long after you’re gone. There are complicated rules around special needs planning, and you may want hire an attorney to create a Special Needs Trust to manage the assets. But there’s no substitute for a permanent life insurance to fund the trust. You can pay the premiums over your lifetime and know that your special needs loved one will be well taken care of after you’re gone.
Author Brian Stallcop, a Certified Financial Planner™ in Bend, Oregon, has been helping clients plan secure futures for more than 20 years. If you have a topic you’d like to see addressed in a future blog post, submit a comment below or drop him a line at [email protected].