What if You Were to Die Today?

By Alan Plafker, PRESIDENT & CEO
Member Brokerage Service LLC
A Melrose Credit Union Service Organization

This month's article focuses on the topic of life insurance. While sometimes overlooked as a finandal planning tool, life insurance Is a necessary cornerstone in the Protection, Savings and Growth pyramid that embodies the overall financial planning process.

Life insurance is a unique asset. Because of its potential high yield and its tax favored benefits, it can be used to solve some of life's perplexing financial problems.

Death Benefit Uses for Life Insurance

  • Create an estate: Where time or other circumstances have kept the estate owner from accumulating sufficient assets to care for his or her loved ones, life insurance can create an instant estate.

  • Pay death taxes and otber estate settlement costs: These costs can vary from a low of three to four percent to over 50 percent of the estate. Federal Estate Taxes are due nine months after death.

  • Fund a buslness transfer: Business owners often agree to buy a deceased owner's share from his or her estate after death. Life insurance provides the ready cash to finance the transaction.

  • Payoff a borne mortgage: Many people would like to pass the family residence to their spouse or children free of any mortgage. Often a decreasing term policy is used, which decreases in face amount as the mortgage balance is paid down.

  • Protect a business from the loss of a key employee: Key employees are difficult to attract and retain. Their untimely death may cause a severe financial strain on the business.

  • Replace a charitable gift: Gifts of appreciated assets to a charitable remainder trust can provide income and estate tax benefits. Life insurance can be used to replace the value of the donated assets. Proceeds from life insurance policies can also be paid directly to a charity.

  • Payoff loans: Personal or business loans can be paid off with insurance proceeds.

  • Equalize inheritances: When the family business passes to children who are active in it, life insurance can give an equal amount to the other children.

  • Accelerated death benefits: Federal tax law allows a “terminally ill” individual to receive the death benefits of a life insurance policy on his or her life income tax free. Such "living benefits", received prior to death., can allow a person to pay medical bills or other expenses and maintain his or her dignity by not dying destitute. If certain conditions are met, a "chronically ill" person may also receive accelerated death benefits free of federal income tax.1

Existing life insurance policies should be reviewed to verify that policy provisions allow for payment of such "accelerated death" benefits. The discussion here concerns federal income tax law; state or local tax law may vary.

Other Uses for Life Insurance

While life insurance products are primarily used for death benefit protection, they are also commonly used for long-term accumulation goals.

  • College fund for children or grandchlldren: Cash value increases in a policy on a minor's life (or the parent's life) can be used to fund college expenses.

  • Supplement retirement funds: Current insurance products provide competitive returns and are a prudent way of accumulating additional funds for retirement.

Available cash values may also serve as an "emergency reserve," if needed, or a source of loans, since life policies frequently include features permitting borrowing against these cash values

A policy loan or withdrawal will generally reduce cash values and death benefits. If a policy lapses or is surrendered with a loan outstandlng, the loan will be treated as taxable income in the current year, to the extent of gain in the policy.

Policies consIdered to be modified endowment contracts (MECs) are subject to special rules.

Many individuals recognize the benefits of planning for the future. Such efforts often uncover problems and frequently provide the motivation to make needed changes. For the most part, the issues involved are positive and enjoyable (e.g., retirement, well-educated children).

However, planning for the unexpected - known as risk management - can be less pleasant. A key part of risk management is answering the question, "What if I were to die today?" Preparing for an untimely death is often referred to as "survivor benefit planning." A subset of estate planning, it addresses the need to keep one's family in their current world, financially.

Understandably, no one likes to contemplate his or her own demise. For some, death seems a distant, future event. Others are simply too "busy." Whatever the reason, delaying this part of planning can result in expensive, unintended, even tragic consequences.

Survivor Benefit Needs

The ultimate purpose of survivor benefit planning is twofold: (1) to ensure that the ongoing income needs of the survivor(s) are met, and (2) to provide for immediate lump sum cash needs.

  • Income needs: How much income wlll the survivors need, now and in the future, to cover the following:

  • Household living expenses: Will the family stay in the same house? Can they afford to? Do they want to? Will they have the option?

  • Additional childcare: Will there be a need for more help with young children?

  • Educational expenses: Will there be enough money for the children to go to college?

  • Lump-sum needs: How much will the survivors need immediately and in cash? Consider the following:

    • Final expenses: More than the funeral, this includes unpaid medical bills, which, after a long illness, can be substantial.

    • Estate settlement costs: Probate expenses, attorney's fees, death taxes, etc.

    • Mortgage payoff and debt reduction: Will it be important to provide a paid-off house? Are there debts that should be retired?

One Final Question

If you died today, would your plan be ready?

In choosing the type of life insurance policy you purchase, consideration must be given to the need which is being filled; e.g., creation of an estate, payment of estate settlement costs (federal and state death taxes, last illness and burial costs, probate fees, etc., business buy-out, key-man coverage, etc.

Decreasing Term

Level premium, decreasing coverage, DO cash value: Suitable for financial obligations which reduce with time; e.g., mortgages or other amortized loans.

Annual Renewable Term

Increasing premium, level coverage, no cash value: Suitable for financial obligations which remain constant for a short or intermediate period; e.g., income during a minor's dependency.

Long-Term Level Premium Term

Level premium, level coverage, 00 cash value: The annual premiums are fixed for a period of time, typically 5,10,15 or 20 years. Suitable for financial obligations which remain constant for a short or intermediate period; e.g., income during a minor's dependency.

Whole Life

Level premium, level coverage, cash values: Cash value typically increases based on insurance company's general asset account portfolio performance. Suitable for long-term obligations; e.g., surviving spouse lifetime income needs, estate liquidity, death taxes; funding retirement needs, etc.

Universal Life

Level or adjustable premium and coverage, cash values: Cash values may increase, based on the performance of certain assets held in the company's general account. Suitable for long-term obligations or sinking-fund needs: estate growth, estate liquidity, death taxes, funding retirement needs, etc.

Under the Tax Act of 2001, the federal estate tax is gradually phased out until its final repeal In the year 2010. If Congess does not act at that time to repeal it for the years following, it will automatically revert back to the rates in effect during the year 2001, with an exemption for the first $1,000,000 of assets.

Variable Life and Variable Universal Life

Level/adjustable premium, level coverage, cash value: Suitable for long-term obligations and those who are more active investors and for estate growth and death tax liquidity.

Single Premium Whole Life

Entire premium is paid at purchase, cash values, level coverage: Provides protection as well as serving as an asset accumulation vehicle.

Note: Withdrawals and loans may be available from permanent policies. Withdrawals and policy loans will have the effect of reducing the death benefit. There are different income tax consequences if they are modified endowment contracts.

Can be increased by positive investment performance. The policy owner directs cash values to a choice of invesment accounts (bond, stock., money market, etc.). However, cash values are not guaranteed.

In subsequent months, their various types of life insurance policies will be discussed in further depth. As with any financial product, it is important as a consumer to know what you are buying - and life insurance is no exception.

Alan Plafker is President of Member Brokerage Service LLC, a Melrose Credit Union Service Organization. He is a licensed Insurance Broker and serves on the Board of Directors the PIANY (Professional Insurance Agents Association of NY) and on the Board of CIBGNY (Council of Insurance Brokers of Greater NY). His Agency insures thousands of polices for TLC Insurance as well as many policies for all types of insurance. You can reach him in his Briarwood, Queens office at (718) 523-1300 ext. 1082.

Information for this article was developed by Edward Huttick, CFP (at ext # 1136) who heads the Life, Health & Financial Planning Department at Member Brokerage Service LLC.

© 2015 TLC Magazine Online, Inc.