Creative Uses for Life Insurance
According to a new study from LIMRA and Life Happens, two nonprofit industry trade associations, a record-high number of American adults—approximately 102 million—either do not have life insurance or do not have enough coverage.[1]
Misunderstandings about how much life insurance costs and what type to purchase are the largest barriers to purchasing a policy. Even among those with a life insurance policy, there are knowledge gaps about how it can be used to meet their financial and estate planning goals.
Two Types of Life Insurance for Estate Planning
About half of US adults (52 percent) report having life insurance coverage.[2] Forty-two percent acknowledge a coverage gap, while 37 percent say they intend to purchase coverage in the next year.[3] You may wonder where you fall on the life insurance continuum.
There are two types of life insurance to consider when engaging in estate planning:
● Term life insurance pays out a death benefit if you pass away during the policy’s “term,” typically 10 to 30 years.
● Whole life insurance remains in effect for the entirety of your life and can build cash value over time.[4]
Several variations exist within these two types of policies, each providing different benefits at different price points. Life insurance policies designed to meet specific purposes, such as those that cover loan balances and final expenses and those that insure two lives (for example, first-to-die and second-to-die policies), are also available.
Life Insurance Perks You Might Not Know About
On the surface, life insurance is a straightforward financial product: you pay premiums in exchange for a tax-free cash benefit that the insurance company pays to your loved ones after your death.
Most people who buy life insurance do so because they have financial dependents. However, life insurance policies can also provide important benefits to the policyholder. From married couples with kids to couples without children, empty nesters, retirees, business owners, and investors, life insurance can provide several perks you may not have thought about.
Here are some creative ways to fit life insurance into your estate plan:
● Funding a trust. Maybe you have a child with special needs or another dependent who requires ongoing care or support. You may want to set aside money to help fund a child’s education, first home, or travel. Or, like many modern families, you may have a blended family with you or your spouse having children from previous relationships. You could even have a beloved pet you want to ensure is cared for if you pass away unexpectedly.
Each of these situations—and many others—can be well-served by naming a revocable or irrevocable trust as the beneficiary of your life insurance policy rather than an individual beneficiary or beneficiaries directly. Funding a trust with life insurance proceeds allows you to set terms on how the money is used and provide for the unique needs of your loved ones. An irrevocable life insurance trust can also avoid probate and may, in some circumstances, reduce estate taxes.
● Paying taxes and debts. For the most part, your debts do not just disappear when you die. In addition to any outstanding creditor claims and income taxes that may be due upon death, dying can trigger estate and inheritance taxes that, if not planned for, can easily drain your estate. You can purchase life insurance to cover your estate's tax payments and other debts and eliminate the need to liquidate your accounts or sell illiquid assets (like a business or art collection) to satisfy these claims.
● Equalizing inheritances. The death benefit of a life insurance policy can be used to help equalize the inheritances for multiple heirs when you would like to give each beneficiary equal value but have assets you do not want to liquidate (for example, a family business, family home, or cottage) to truly make things even. For example, if one child wants to keep the family vacation home and the other wants to sell it, you can gift the home to the former and buy a life insurance policy equal to the home’s value to benefit the latter. As another example, if you want to give your family business to a child who works in the business but have no assets or insufficient assets to give your other children, a life insurance policy can give an equalized inheritance to those other children.
● Making philanthropic donations. Nothing says you have to name a loved one as a life insurance policy beneficiary. Your policy, in part or in whole, can be a gift to a charity or a nonprofit organization. However, before structuring a life insurance policy to benefit a charitable cause, check with the organization to ensure all applicable procedures are followed.
● Paying final expenses. It is not just the cost of living that has gotten more expensive. Funeral and burial expenses are also surging and can easily run $8,000 to $10,000 or more.[5] Further, approximately 6 percent of US adults owe over $1,000 in medical debt, which may still be owed at the time of a person’s death.[6] A specialized type of life insurance policy, or final expense life insurance, can be purchased to cover end-of-life expenses like funeral and medical bills.
How to Fit Life Insurance into Your Estate Plan
Life insurance, like estate planning, is for everyone. No matter your stage of life or circumstances, adding life insurance to your estate plan can give you and your loved ones flexibility to deal with expected and unexpected expenses in the future.
If you are one of the more than 100 million Americans facing a life insurance coverage gap, we can help you and your trusted advisors craft a plan to bridge that gap with policy advice that fits your needs, situation, and budget. Schedule a meeting with our attorneys to discuss how life insurance can strengthen your estate plan.
Who Should You Name as a Beneficiary?
The proceeds from your life insurance policy can benefit your loved ones in many ways, from paying off your outstanding debts to providing supplemental income for your spouse and children to covering funeral and burial expenses.
Life insurance policy payouts average $168,000.[7] As the policyholder, you can—and should—name beneficiaries of the policy. Generally, however, when a policyholder passes, the named beneficiaries receive their share of the death benefit outright and in a lump sum without stipulations or conditions.
You likely purchased life insurance to protect those who depend on you. To make the most of your policy, consider who you name as a beneficiary and how the death benefit distribution method fits into your overall estate plan.
Who Can Be Named as a Beneficiary
A life insurance policy can name a single individual, two or more people, the trustee of a trust, a charity, or your estate as a beneficiary.
You must name both “primary” and “contingent” beneficiaries. The primary beneficiary is the first to receive death benefits from the policy. A contingent beneficiary serves as a backup if the primary beneficiary cannot be located or is dead. If none of the primary or contingent beneficiaries can be found, the death benefit is generally paid to the policyholder’s estate. However, this is not always the case; it is important to review your life insurance policy's terms to ensure you understand what will happen when you pass away.
When filling out beneficiary designation forms, you should name beneficiaries as clearly as possible by including their full legal names and Social Security numbers (if necessary). Some forms request phone numbers and addresses as well. While this information is usually optional, it is always a good idea to be as complete as possible. In addition, your beneficiary designation forms should be periodically checked and kept up-to-date to reflect life changes, such as the birth of a child, marriage, or divorce.
Although you—the policyholder—name beneficiaries, the beneficiaries choose how they collect the death benefit payout if there is more than one way the insurance company will distribute death benefits. Most insurers allow for lump-sum, installment, specific income, or annuity payouts. One benefit of designating beneficiaries is that this money passes outside of probate (the court-supervised process of settling your affairs at your death).
Surviving Spouse and Child Beneficiaries
If you are married and have kids, you will likely name your spouse and children as policy beneficiaries. The death benefit you leave them can be a significant financial change. It could help pay off a mortgage, assist the children with college expenses, or fill the cash flow gap resulting from the loss of your contribution to household income. Naming a spouse or children as beneficiaries of a life insurance policy comes with a few potential catches, though.
Spouse
Naming your spouse as a life insurance beneficiary is an obvious choice. The policy proceeds can be used to pay off debts you owe individually or as a couple.
Because the money passes outside of probate, your creditors likely will not have access to the death benefit. However, the death benefit is fair game to your spouse’s creditors once the money is paid out to them.
While using a life insurance death benefit to pay off debt may ultimately be in your spouse's best interest, you should make sure that you purchase enough insurance to adequately cover your debts—and their debts—if this is your intention.
Adult Children
Unlike your spouse, as it relates to certain debts, your children likely will not be personally responsible for your debts after you die, at least not directly. But they may have to pay your creditors from the accounts and property you leave behind at your death through the probate or trust administration process. A life insurance policy can help ensure that other accounts and property (for example, your family home, bank accounts, and investment accounts) go to your loved ones, not debt obligations.
Also, keep in mind that once your adult children receive a life insurance payout, their own creditors can access the money. While paying off debt could benefit them, you might prefer that the money be utilized for something else, like schooling or living expenses.
Minor Children
Insurance companies are not permitted to pay life insurance benefits directly to minor children because they cannot legally own or receive accounts or property in their name until they reach the age of majority. A guardian or conservator might have to be appointed to manage the funds until the child comes of age. This entails added court costs, and the proceedings could hold up the payment depending on your state. Once your child reaches the age of majority, they will likely receive the balance of their share of the insurance proceeds outright in a lump sum.
Some life insurance policies allow a custodian to be assigned to a minor child beneficiary without probate court involvement. A custodian manages the money on behalf of the minor child until they come of age, at which point the money is turned over to them, again, usually in a lump sum.
Charity
Your legacy and estate plan might extend beyond your family and include a charity or nonprofit organization.
You could purchase a new life insurance policy to make a charitable gift, change the beneficiary designation of an existing policy to a charitable organization, transfer policy ownership to a charity, or give the gift of policy dividends to a charity. Each option can provide tax benefits that leave more money in your estate.
Creating a Trust for a Loved One
By creating a trust as the beneficiary of the life insurance policy, you can protect the proceeds from creditors and exert more control over how the death benefit is spent.
For example, a life insurance trust can be used to do any of the following:
● Leave money to minor beneficiaries
● Retain means-tested government assistance eligibility for a disabled loved one
● Keep a young adult from spending the funds all at once or for nonapproved purposes, such as personal expenses instead of their college education
● Prevent commingling the insurance proceeds into marital property if your spouse remarries or your adult child gets divorced
Life insurance proceeds held in trust add assurances that a death benefit will be spent in accordance with your wishes. Trust funds are exempt from probate and may reduce estate taxes, depending on the type of trust used.
Life Insurance and Your Estate Plan
Purchasing life insurance is one of the best ways to provide financial security for your loved ones after you are gone. But if you are not careful and thoughtful about naming beneficiaries, they may not receive the protection you hoped for.
To make the most of life insurance in your estate plan, schedule a meeting with our attorneys to review your plan.
Do You Have Enough Life Insurance?
About 90 million Americans depend on life insurance for financial protection and retirement security.[8] An almost equal number say that they either do not have any life insurance or need more life insurance.[9] More than one-third say they plan to purchase coverage in the next year.[10]
With very few exceptions, life insurance can benefit everyone. Owning life insurance is necessary, especially if you have dependents. But while you might understand that buying life insurance is a good move, you may be unsure whether you have enough, how to determine the ideal amount for you and your family, and where life insurance fits into your overall financial and estate plans.
Life Insurance Statistics and Trends
According to the 2024 Life Insurance Barometer Study from LIMRA and Life Happens, two nonprofit industry trade associations, about half of US adults report having life insurance.[11] The study found that more than 100 million Americans are living with a life insurance gap—the highest number in the study’s 14-year history.[12] This gap is higher among women than men and highest among Americans earning less than $50,000.[13]
For the last five decades, the percentage of American adults with life insurance has steadily declined, from over 80 percent in 1975 to just 52 percent in 2023, says Guardian Life.[14] Coverage amounts are also declining, even as the cost of living continues to rise.[15]
Top Reasons to Buy Life Insurance
Most people buy life insurance to provide tax-free income replacement to their family in case they suddenly pass away.
Insurance experts recommend buying life insurance with a death benefit equal to at least 10 times your salary.[16] For example, if you earn $50,000 per year, you would want to buy a minimum of $500,000 in coverage.
A $500,000 policy might sound like a lot of coverage, but this amount does not exist in a vacuum. It must be considered alongside factors like family size, debt levels, and financial goals—all of which can change and require additional coverage.
You may also need more coverage if you are using life insurance for a purpose other than (or in addition to) leaving money to your loved ones.
Other reasons to buy life insurance beyond income replacement include the following:
● Using the cash value to pay off a loan, protect existing assets, or build an emergency fund
● Making charitable contributions
● Funding buy-sell agreements for a business
● Providing flexibility to your estate plan
● Covering specific expenses, such as a child’s education, wedding, or travel, with a life insurance trust
How to Purchase the Right Policy and Amount
Most insurers offer coverage limits ranging from $100,000 to several million dollars per policy. Insurers often cap individual policies at $5 million to $10 million, although you can have more than one policy. There are many reasons why you might want to have multiple policies.
From term life and whole life to variable life and group life to nontraditional policies like indexed life and supplemental life, you should focus on the policies that make sense for your needs and goals. However, this may not be as simple as it sounds.
The reasons for buying life insurance—and the corresponding coverage amounts needed—can change over time. Here are some situations that could prompt you to reconsider your life insurance coverage:
● You recently started a family, and your employer-provided group life insurance is no longer enough
● Your family has grown, and your life insurance policy should grow accordingly
● You have taken on a significant amount of debt
● You purchased term life insurance earlier and now want the benefits of whole life insurance later in life
● You have retired and no longer have your employer-provided life insurance policy
● Your income increased
● Your stay-at-home spouse is uninsured
Talk to an Attorney about Life Insurance and Estate Planning
The reasons for buying life insurance are as varied as the available policy types. If you are among the more than 100 million Americans facing a life insurance coverage gap, an attorney, working with a financial planner and insurance agent, can ensure you purchase the right policy and maintain the right amount of coverage.
Your life insurance policies and estate plan should be revisited every three to five years. Even if you have enough insurance, we often see policyholders making mistakes such as naming their estate as the beneficiary, not updating beneficiary designations, not naming contingent beneficiaries, and naming minor children or special needs beneficiaries without setting up a custodian or trust.
It can be a mistake to silo your financial planning, retirement planning, wealth management, and estate planning. By viewing them as parts of a whole, overarching plan that serves the same overall goals, you and your family will be better prepared for the future.
Please meet with our attorneys today to start planning for your future.
[1] U.S. Life Insurance Need Gap Grows in 2024, LIMRA (Apr. 15, 2024), https://www.limra.com/en/newsroom/news-releases/2024/u.s.-life-insurance-need-gap-grows-in-2024/.
[2] Jennifer Lobb, Life insurance statistics and industry trends 2024, USA Today (Jan. 24, 2024), https://www.usatoday.com/money/blueprint/life-insurance/life-insurance-statistics/.
[3] U.S. Life Insurance Need Gap Grows in 2024, LIMRA (Apr. 15, 2024), https://www.limra.com/en/newsroom/news-releases/2024/u.s.-life-insurance-need-gap-grows-in-2024/.
[4] Cash value is the portion of a life insurance policy that accumulates over time and may be available to the policyholder to withdraw or borrow against during their lifetime.
[5] Rebecca Lake, How much does a funeral cost in 2024?, USA Today (Apr. 10, 2024), https://www.usatoday.com/money/blueprint/life-insurance/how-much-does-a-funeral-cost/.
[6] Shameek Rakshit, et al., The Burden of Medical Debt in the United States, KFF (Feb. 12, 2024), https://www.kff.org/health-costs/issue-brief/the-burden-of-medical-debt-in-the-united-states/.
[7] Average Life Insurance Payout, AFLAC, https://www.aflac.com/resources/life-insurance/average-life-insurance-payout.aspx (last visited May 28, 2024).
[8] News Release, American Council of Life Insurers (ACLI) Statement on Proposed Labor Department Regulation, ACLI, (Oct. 31, 2023), https://www.acli.com/posting/nr23-070#:~:text=The%20American%20Council%20of%20Life,financial%20protection%20and%20retirement%20security.
[9] U.S. Life Insurance Need Gap Grows in 2024, LIMRA (Apr. 15, 2024), https://www.limra.com/en/newsroom/news-releases/2024/u.s.-life-insurance-need-gap-grows-in-2024/.
[10] Id.
[11] Id.
[12] Id.
[13] Jennifer Lobb, Life insurance statistics and industry trends 2024, USA Today (Jan. 24, 2024), https://www.usatoday.com/money/blueprint/life-insurance/life-insurance-statistics/.
[14] Prepared and Protected, Guardian 12th Annual Workplace Benefits Study, Guardian, https://www.guardianlife.com/reports/prepared-and-protected (last visited May 28, 2024).
[15] Id.
[16] Andrew Beattie, How Much Life Insurance Should You Have?, Investopedia (May 24, 2024),https://www.investopedia.com/articles/pf/06/insureneeds.asp.
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