When clients are in their early career years, working hard to establish themselves and starting a family, not enough time and effort is placed on setting assets aside to protect the family for the future. The thought process usually is that with hard work, we will be able to save sufficient assets for putting our children through school and providing a nice nest egg for our retirement years. However, what happens if plans go awry and the client dies unexpectedly? The family loses someone who was previously contributing to the payment of day-to-day living expenses. This can have a significant adverse effect on the lifestyle or future plans of the surviving spouse and children. This is the perfect time to consider the need for life insurance to provide that protection.
Life insurance can provide protection for a spouse and children in the event a client dies prematurely. A life insurance policy can provide funds to pay family living expenses and college education costs. It can replace the income stream lost when one spouse passes away unexpectedly, and allows the family to maintain a standard of living is otherwise lost because of that death. At this stage in a client's life, term life insurance is probably the most economical way of funding this family protection. The relatively low cost of term insurance at young ages makes it affordable for families on a limited budget. The policy can be designed to protect for a finite number of years, (for example 10, 15, 20 or 30), depending on the length of the term insurance contract chosen. If the client dies at a young age, funds are available so a family's lifestyle can be maintained and dreams of college for children can be met. If the client lives to middle age and beyond, he builds a significant estate to protect the client and family in retirement years. In that case, the client lets the policy lapse or terminates it because it is no longer necessary.
Sometimes clients have targets for what they would like to leave to their children at their death. Clients often use life insurance to fund the difference between actual assets and the theoretical target set by the client. For example, if a client has five children and wants to pass on $500,000 each of death, a client needs $2,500,000. If the client only has $1,500,000 in assets, the difference can be funded with a life insurance policy at a much smaller cost on an annual basis than hoping to save the difference before the client dies.
Some of my clients have used life insurance fund a bequest to a child while giving a specific asset to another child that values that asset. For example, the largest asset of a client’s estate may be a business in which only one of the children are active. The client desires to leave the business to that child, yet does not want to be unfair to any other children. By purchasing a life insurance policy of equal value to the business, the client can assure that there will be sufficient assets to provide an equal split of value between us children.
On occasion, a client has used a life insurance policy to fund a special needs trust for a particular child, leaving the remainder of assets to other children in order to make certain that none of the estate is required to be used for the special needs child in lieu of government benefits.
Clients who are fortunate enough to have assets in excess of lifetime exclusion of $5,000,000 can use life insurance to replace the amount of the estate loss to estate taxes. These amounts can be replaced on a leveraged basis using life insurance because the cost of a life insurance policy, whether a term policy or a permanent policy will never exceed the face value of the policy. The replacement of the assets using life insurance policy is funded at a fraction of the cost. In a situation such as this, where a life insurance will always be useful, it may be more appropriate to use a permanent policy and continue to pay premiums, because a term policy has a finite existence and may lapse or terminate or become too expensive at a time when it would be most needed. While many clients worry about the costs reducing their livestock, the reality generally is that the life insurance premiums will be paid from excess assets, not assets being currently used to support the client's lifestyle that the payment of premiums will come from excess assets, not assets otherwise used to support a client's lifestyle.
For many years, the funding of a retirement benefit or savings using a permanent life insurance policy has been out of favor for a number of reasons. Some commentators are now suggesting that because of the income tax changes in the most recent tax law, which raise income tax rates on investment income, and dividends for some taxpayers, using a life insurance policy as an estate builder can be valuable because of the tax-deferred buildup of the value of the policy. While this remains to be seen, at least make sense to consider this as a possible planning option.
Whether a term policy or permanent policy makes sense will depend upon the intended use for the proceeds. Whatever type of policy is purchased, it will usually make sense to purchase it sooner than later because life insurance is less expensive for younger, healthier clients, resulting in smaller premiums. Using life insurance, goals can be met even if an unexpected death or other event occurs for a family. Clients should always discuss the purchase of life insurance with an experienced life insurance professional and their estate planning attorney.