Death is a difficult topic to discuss and think about, especially when it comes to planning for your own mortality. To minimize the amount of time thinking about death, people will often use simple formulas or arbitrary numbers to get to the "right" amount of life insurance. This usually works out fine, but it doesn't always explore why you need that amount of insurance. If you don't think life insurance is for you or are on the fence about it, here are 9 reasons why you might consider exploring life insurance for you and your family.
You have debt
Debt you own individually is generally the responsibility of your estate and not your heirs, but any outstanding debt will reduce the amount of money distributed to your heirs. Life insurance payouts are typically protected from creditors as long as they aren't paid to your estate, so even if you die with more debt than assets that can be sold (hopefully that won't be the case!), your beneficiaries can get the insurance payout without having to worry about your creditors. Even if your estate has ample assets to cover your debts, liquidity issues might arise when covering debts and other liabilities – it could be financially advantageous to name your estate as a beneficiary in certain cases.
If you have any jointly-owned debt or someone else has co-signed your loans, the joint owner or co-signer becomes responsible for your debt. If you live in a community property state like California (and are married), the community property portion of debt will become your spouse's responsibility. Life insurance can ensure others don't bear responsibility for your debts.
For mortgages on residential property, federal law allows heirs to acquire the mortgage balance without underwriting. However, even though they can take over the mortgage without having to qualify, if they can't afford the mortgage the property may have to be sold. In the case of a primary residence or other personally significant property, this can cause additional stress and anxiety.
Funeral costs and final medical expenses aren’t cheap
Funerals aren't cheap, with median costs in 2019 coming in around $6,650 for cremation and $7,650 for a traditional burial according to a study by the NFDA. With more bells and whistles a $10,000 price tag isn't out of reach. Your estate will usually pay for it, but there may be a time lag between payment due and when your estate releases funds. The costs might accrue interest (depending on the funeral home), or your family may cover the costs temporarily – relieving that burden might be something to consider.
Final medical expenses can be in the thousands of dollars or more – even with a bulletproof Rolls-Royce health insurance plan. Unlike funeral costs which can be estimated, this isn't always the case for medical expenses, which could span multiple years or face unforeseen hurdles with insurance coverage.
You want to continue support for children or aging relatives
If you financially support children, aging parents, or other relatives, life insurance can provide the reassurance that their financial needs will continue to be taken care of. In particular, providing for a child's higher education is often a high priority for parents, and a life insurance payout can be structured in a way to ensure your wishes are followed (or left to a trusted beneficiary).
This can be further expanded to cover your entire family’s needs with the “needs-based” approach to calculating life insurance amounts.
You want to replace your income for your family
Whether you're the primary earner or part of a dual-income family, the loss of your income could hurt your family's lifestyle. The extent of that is largely dependent on your individual circumstances, but using life insurance to replace some or all of your income can relieve the financial burden for your spouse and children.
The desire to replace income can lead to the “income multiple” or “human life value” approaches, but ignore the needs of survivors and focuses primarily on the financial considerations of the lost income.
You’re a non-earner but have household contributions
Taking care of children, housework, etc. are all important contributions that would need to be replaced in the event of your passing. Whether that comes as a time investment by your spouse or they spend money to outsource it, there is value associated with these non-income-producing contributions. Life insurance can reduce the financial burden of ongoing costs or provide your spouse with the financial flexibility to spend more time with family.
You have a significant amount of stock options or a concentrated equity position
Unexercised stock options are valued in the estate at FMV minus exercise price, and owned shares are valued at FMV. If this pushes your estate above the $11.58 million exemption amount for 2020, your estate may have to pay estate taxes. If there isn't a readily-available market for your company's shares, this can create a liquidity issue for your estate.
Even if your estate is under the exemption amount, your heirs still need to pay the exercise cost to own the shares, potentially creating cash flow or liquidity problems for heirs wanting to own the stock.
As a note, income taxes may differ between ISOs and NSOs, with different basis step-up rules and deductions for estate taxes paid, but that requires a deep dive into your specific tax situation and is beyond the scope of this piece.
Your estate exceeds the exemption limit
As mentioned above, if your estate exceeds the estate tax exemption amount, you may have to pay estate taxes. Life insurance with your estate as the beneficiary can be used as a liquid source of funds to ensure assets don't need to be sold off to pay the tax liability.
You support a cause that's important to you
Whether your goal is to contribute to a cause with a portion of your income over your lifetime or to build enough wealth to fund your legacy goals by the time you die, your untimely passing can throw a wrench in your charitable goals. A life insurance policy can ensure your legacy goals are achieved.
You may not be able to get life insurance later
Getting life insurance in your 30s or even 20s might not seem to make sense, but insurability can disappear suddenly if you start experiencing health problems. This could drive your premium costs up or even make you uninsurable. Remember that insurance is designed to protect against unexpected and severe events – as those trigger events become more likely, insurance will become more expensive or even completely unavailable.
Life insurance is complex and a very personal aspect of personal financial planning. It can be used in many ways and for many purposes. Because of the vast array of policy choices you can make, it can be easy to make missteps in your coverage decision or be led astray. None of the above should be taken as any recommendation to buy life insurance or designate certain beneficiaries for your policies.
When evaluating your life insurance decisions, I highly recommend consulting an independent, fiduciary financial planner. There are many fantastic life insurance agents and brokers out there who truly want the best for you, but I’ve heard about and seen firsthand the consequences of bad actors too many times. If you’d like a complimentary consultation and analysis of life insurance within the scope of your broad financial circumstances, feel free to send me an email or schedule a time to talk!
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