Insurance and risk management
As parents, we instinctively want to protect our family members. Planning evolves around: What if I die too soon? What if I live too long? What if I become disabled along the way? How can I protect my family’s financial security in the event of my premature death or disability?
Your savings will provide resources for your family however, you may utilize various planning tools to transfer the financial risks that you cannot personally save for to insurance companies.
Life insurance basics
What is life insurance?
Life insurance is a contract with an insurance company whereby the policy holder (or owner) of the policy pays a recurring premium to the company in exchange for an income tax-free, lump-sum payment, known as a death benefit, to the named beneficiaries upon the death of the insured individual.
Why purchase life insurance?
It is a tool that allows you to provide a larger sum of money to your heirs when you die by making smaller premium payments for a specified period of time, or your lifetime. The two most important considerations are pricing and the financial strength of the insurance company.
Life insurance has many purposes and generally, we recommend including it as part of your financial and estate plan. Insurance may be used to:
- protect your family’s lifestyle
- provide estate equalization among heirs
- provide liquidity for estate taxes
- fund a special needs trust (SNT)
Other considerations include:
- The type of benefit to choose; insurance companies provide illustrations that have both assumed values and guaranteed values. A guaranteed benefit is especially important on a permanent type of life insurance policy because you want to make sure that no matter how old you are when you die you will still have the death benefit available to your heirs.
- The ownership structure of the insurer; mutual ownership or stock ownership.
- Your agent: you may wish to work with an independent advisor who has access to many different companies and products to help meet your needs.
Common types of permanent life insurance include:
- Whole life insurance, also known as ordinary life insurance.
- Universal life insurance, also known as adjustable life insurance.
- Indexed universal life insurance.
- Variable universal life insurance.
- Second-to-die life insurance, also known as survivorship life insurance.
Whole life insurance or ordinary life insurance is one of the oldest forms of permanent life insurance and often has the highest premiums because the insurance company assumes a larger portion of the risk because it guarantees both the death benefit and the cash value of the policy. The policy has a guaranteed premium, death benefit and cash value. The policy can pay an annual dividend, which is determined by the insurance company. Dividends, which are not guaranteed, can be used toward premium payments, received in cash, or retained in the policy to increase the death benefit or cash value of the policy.
Universal life insurance or adjustable life insurance is a type of permanent life insurance where the insurance company transfers risk to the insured but provides flexibility in the premium payment schedule. After your initial premium payment, you may change the premium payment amount. The amount may also be subject to requirements for a certain minimum or maximum amount. This type of policy also allows you to reduce or possibly increase the death benefit more easily than a traditional whole life policy.
To increase your death benefit, the insurance company will require you to furnish satisfactory evidence of your continued good health. Premiums and the death benefit are not guaranteed unless specifically stated in the contract or in a rider; you pay extra to add the guarantee. This type of policy builds cash values based on interest rates and assumptions used by the insurance company. It should be noted in the event that you do not pay adequate premiums, or the cash value grows less than anticipated, the policy can lapse or end without value.
There are also Indexed universal life insurance policies which build cash values based on linking the credited interest rate paid to the performance of a stock market index.
Variable universal life insurance is another type of permanent life insurance, similar to universal life, in which instead of using interest rate assumptions, the policy cash value growth is dependent on an investment component, using a variety of sub-accounts available within the policy.
Second-to-die life insurance or survivorship life insurance is a type of life insurance coverage that insures two people and pays the death benefit at the death of the second insured person. The premiums are significantly less than they would be for two traditional insurance policies, because the policy insures two lives and pays one death benefit upon the death of both insureds.. For older individuals with some health considerations, this may be a viable option to consider for coverage. This type of policy can be designed using any of the above policy types of whole life, universal life, indexed universal life, and variable life. Regardless of the type of coverage, a second-to-die policy should have a guaranteed death benefit provision. Second-to-die insurance is frequently used by families caring for an individual with disabilities because the major concerns usually develop at the death of the second parent (or caregiver). This is the time when money is often needed the most.
PRIOR TO PURCHASING INSURANCE BE SURE :
Read and understand the contract definitions, access to benefits, and guarantees.
Research the financial strength of the insurance company. This is based on their ability to pay claims.
If you also have the ability to access government benefits to be the adult family care provider under Medicaid provisions, you will not be able to be your child’s guardian. Careful consideration should be given when choosing the parent to serve as guardian while the other parent serves as the Medicaid provider.
Whose life will be insured and for how much?
Buying life insurance is a very easy way to pay smaller amounts for premiums and leave a larger sum of assets, income tax-free, to be available for your child’s lifetime needs after you die. But it is critical to purchase the proper type of insurance from a high-quality issuer and to be sure to cover the correct people.
Don't overlook the caregiver & advocate. People often assume that the parent (or other adult) who earns the most money needs the most life insurance. In two-parent families, many times one parent is the primary wage earner and one parent, even if employed full-time or part-time, is the primary caregiver of the children. This often is the case with families having a child with disabilities. One of the most common errors families make is to purchase life insurance only on the wage earner. while foregoing insurance to address the cost of replacing the person’s care provider and primary advocate.
To effectively plan using insurance, it is important to carefully consider some questions:
How much insurance do you need?
Every family situation is unique and there is no one magic number that suits everyone. The expertise of a professional may be needed to provide guidance in developing your life insurance needs over the course of a lifetime. Insurance companies have developed online calculators that are good tools to get you started before having a conversation with a financial professional. First, gather your data.
Begin with making a list of your family’s needs and living expenses, including the projected cost of insurance premiums. What you can afford in premiums will have a big impact on the type of insurance you use in your planning.
Step 1 - To help you prioritize what amounts are needed, during what time periods, and what goals are most important, it is helpful to categorize needs and living expenses for your family into 4 categories:
- Immediate lump-sum needs - e.g. burial expenses, taxes, paying off the mortgage or debts, and keeping a cash cushion for about 6 months of emergency reserves to give your family time to make decisions and the ability to meet expenses.
- Income for your family’s lifestyle needs - e.g. your essential expenses, additional childcare or home care, maintenance and repairs for your home.
- Future goals for you and your entire family - e.g. funding for a portion or all college tuition for all children, perhaps a wedding or a down payment on a home, paying off your existing mortgage or providing for the surviving spouse’s retirement income needs.
- Supplemental expenses for your child today and in the future
Step 2- Put together a picture of your family's total resources. These include income from earnings and benefits for both parents and children and an inventory of parents' assets and your child's assets.
Step 3 - To determine the net need for your family to maintain their lifestyle and future goals, subtract the resources that will be available at the death of a parent. This is the amount of money needed from life insurance.
Should Term and Permanent Insurance be combined?
Often, it is cost-effective to combine different types of life insurance for different types of needs. Your need for life insurance may change overtime and it is good to review the amount and type of coverage you have as you build savings.
Term life insurance may be indicated to provide protection in the event of loss of income, paying off mortgage balances, providing for college and retirement goals, or providing for other goals that will likely be pursued over time if the parent continues to live. Term life insurance, which has lower premium costs, but provides a higher death benefit coverage than a permanent insurance product.
However, if you are planning for a child with special needs, those support needs are not temporary, and likely will be permanent. This requires permanent life insurance protection to last throughout the parent’s lifetime and pay out after your death. It is often ideal to have a combination of term and permanent coverage, for example, purchasing a lower amount of death benefit with a permanent policy, to keep premiums manageable, and purchasing a larger amount of death benefit coverage in a term policy that has lower costs.
Second-to-die life insurance or survivorship life insurance is a type of permanent life insurance coverage that insures two people and pays the death benefit at the death of the second insured person. The premiums are significantly less than they would be for two traditional insurance policies, because the policy insures two lives but only pays, upon the death of both insureds, one death benefit. For older individuals with some health considerations, this may be a viable option for coverage. Second-to-die insurance is often used by families caring for an individual with disabilities because the major concerns usually develop at the death of the second parent (or caregiver). This is the time when money is often needed the most.
If your family receives a large windfall or significant inheritance, you may not have to use insurance to cover the cost of your child’s lifetime supports, but it still may be worth exploring for other uses such as estate taxes.
What Do I Do With Existing Policies?
Every 5 or 10 years it makes sense to review your existing life insurance policy or policies to make sure they still apply to your current needs and goals. Review the policy you purchased and see what it looks like now as compared to the sales illustration used at the time of purchase, specifically the estimated and/or guaranteed premium payments, cash values, death benefit amounts, and any riders that are available each year.
To see what has changed, if anything, request an in-force illustration from your insurance agent or directly from the insurance company. The in-force illustration will provide you with a current snapshot of what your policy values are right now and what they will look like in the future. As part of your review, ask these questions:
- Will the death benefit lapse at some point?
- Will I need to increase my premium payments?
- Will the dividends be enough to pay for the premiums?
- Do I have an outstanding loan on the policy? If so, how will I be able to pay that off or how will it affect my policy over the long term?
- What options or riders do I have on the policy, and are they still appropriate?
A handy reference guide
Incorporating life insurance into your planning? Download a printable PDF of the info on this page to share with your advisors.
Insurance Planning Stories
Reba and Maguire had purchased variable universal life insurance policies many years ago. The intent was that when one of them died, life insurance would provide for the surviving spouse as the primary beneficiary, and then fund their daughter’s SNT as the second beneficiary.
Upon review of various in-force illustrations, they realized that they had underfunded the premiums, the cost of insurance increased as they aged, and the policy would likely lapse in their early 80s. They no longer needed the large death benefit amount they had originally purchased. Because both of their families had longevity and they were quite healthy, they were able to replace their old policies with current policies that would not lapse until their age 120. They were able to use the cash value from the old policies to help pay the premiums on the new policies by electing to use an IRS Section 1035 tax-free exchange. The IRS Section 1035 tax code is a provision that allows a policyholder to transfer or exchange funds from a life insurance policy or annuity contract to a new policy without incurring any taxes. The new policies also provided an LTCI rider in the event that either of them needed long-term care assistance.
Arthur was in his late 70s when his wife died, and he decided to review his life insurance policies that he purchased many years ago. He and his wife had very successful careers and had accumulated enough savings to be quite comfortable for their lifetime and provide a thoughtful inheritance for their family upon death, without including the proceeds of the life insurance policy.
After further discussions, Arthur decided to gift the policy and transfer ownership during his lifetime to their local NAMI organization, where he and his wife had been very involved over the years and make annual donations. In addition to providing a substantial gift to the organization, he was able to take a tax deduction that was equal to the total premiums paid. The tax deduction is limited to the lesser of the premiums paid or the cash value of the policy. Upon receiving the gift, the charity had the choice to either continue paying the premiums or to cash in the policy. Although the cash value was significant, NAMI determined that it was best to continue to pay the premiums in anticipation of receiving the substantial benefit when Arthur passes away. This plan worked out well for both—for the family’s current tax planning, and the anticipated proceeds will be by far the largest gift the organization will receive. In addition, if the charity needed the proceeds earlier, they could always cash in the policy.
Ready to start planning?
It may not be possible to know exactly what will be needed to provide for your family's future needs and goals. By moving forward and working with a plan, you are doing all you can to care for and protect your family's future.
- The Special Needs Planning Guide, How to Prepare for Every Stage of Your Child's Life, Haddad/Nadworny, 2021, Brookes Publishing.
Affinia Financial Group conducts business under the Special Needs Financial Planning name. Advisory services offered through Affinia Financial Group, LLC, a registered investment advisor.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual, nor intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor. There is no assurance that the techniques and strategies discussed are suitable for all individuals or will yield positive outcomes.
The experiences described here may not be representative of any future experience of our clients, nor considered a recommendation of the advisor's services or abilities or indicate a favorable client experience. Individual results will vary.