If your financial assets are insufficient to take care of your family and liquidity needs, life insurance is an inexpensive way to fill that gap. Life insurance comes in many varieties. The two basic types are whole life and term life insurance. The premiums for whole (also called permanent) life insurance is more expensive because it generally includes a savings factor or cash surrender value. Term insurance is much less expensive and creates a death benefit without any savings value. For young couples, inexpensive level term life insurance is a method to create a substantial amount of death benefit if the insured dies early in his or her career. Term also has an expiration date when the policy ends. Assume David Jones, age 32 and in good health, has two children ages 6 and 3. His financial assets are less than $100,000. A 20 year level term life policy for $1 million would cost less than $600 in annual premiums from a top rated insurer. If the Jones’ wish was to fund a college education for his two children it would be prudent for Jones to purchase term insurance for the amount necessary to support his wife and cover schooling for his children for the next 20 years. Assuming Mr. Jones lives to see his children attend college, the 20 year policy would expire. Jones, of course, would supplement the life insurance with a college savings plan through a pre-paid college fund, 529’s and a Uniform Gift to Minor’s Trust (UTMA).
Another use for life insurance would be to cover a 30 year mortgage for a young couple If both the husband and wife are bread winners in the family then both should be insured. In this example, a fixed level premium 30 year term policy for a husband and wife age 32 would cost less than $1,000 annualy for each policy. At the end of the 30 years the mortgage would be paid off and the term policies would expire. If the couple is prudent about saving money and investing wisely it is possible their financial assets will grow to the point that the insurance may be cancelled prior to the end of the 30 year cycle.
A common method used to give assurance that the death benefit from life insurance will be used for its intended purpose is to set up an irrevocable life insurance trust. The trust owns and is the beneficiary of the policy if the insured passes away. The trust directs the trustee to use the proceeds according to the insureds wishes. The common language is “support of the family and education of the children.” There often is an independent trustee appointed who is obligated to ensure the funds are invested prudently and last long enough to fulfill the wishes of the insured.
When purchasing any type of insurance, it is prudent to discuss with your estate planning lawyer, financial advisor and insurance consultant about the amount, type and ownership of the life insurance.
Estate planning can be quite complicated, especially when adding in second marriages, children, charities, and how all of these heirs, beneficiaries, and trustees receive those assets. These topics and more will be discussed in the next part of this series.
Next time: Financial Planning Basics- Part VI: Estate Planning