Throughout the course of your adult life, you will likely make numerous changes and revisions to your estate plan. Life insurance will likely be a part of that plan; however, the role it will play may change considerably over the years. Having a clear understanding of how life insurance works, what types of life insurance are available, and the different goals life insurance can help you reach within your estate plan are all critical to making the most of your estate plan. Toward that end, the attorneys at Legacy Care Law Firm have prepared a guide to life insurance and your estate plan to help you.
Types of Life Insurance
When you purchase a life insurance policy, you will be given several options from which to choose. Deciding what type of life insurance fits your needs and your finances is the first decision you will need to make when purchasing life insurance. The most common types of life insurance include:
- Term Life Insurance. The simplest and least expensive type of life insurance, term insurance is purchased for a specific amount of coverage and a specific “term”, typically 10 to 30 years. Premiums are fixed and the policy only provides a death benefit. There is no cash value. If you outlive the policy, or miss a payment, you lose the money paid to date as well as the death benefits.
- Whole Life Insurance. Purchased in a specific amount for the lifetime of the insured, “whole life” premium payments are usually higher and fixed. Along with death benefits, you also get a savings component that earns dividends, and the policy has a guaranteed cash value.
- Universal Life Insurance. Also purchased for a specific coverage amount but with an option to increase the coverage amount later under certain conditions. The policy accumulates a cash value that can be used to lower premium payments down the road or may be borrowed against. Unlike whole life, universal life has a termination age, though usually not until 95-100 years old.
- Variable Life Insurance. Another variation of whole life insurance, variable life combines life insurance with investing by letting you use the accumulated cash value to invest in stocks, bonds, or mutual funds. You can also increase or decrease the amount you pay in premiums using your cash value.
- Final Expense Life Insurance. Final expense life insurance is a specialized type of life insurance intended to help cover the costs associated with your death, is only available to people of a certain age, and usually terminates at a designated age.
How Much Life Insurance Do I Need?
The second important decision you need to make when including life insurance in your estate plan is how much life insurance you need. Several common formulas are used to determine how much life insurance to purchase, including:
- Assets minus debts. Add up the value of all your assets and subtract the amount you owe in debts with a small cushion for additional debts and/or funeral expenses.
- Assets minus debts plus future income. Take your yearly income and multiply it by the number of years you wish to replace that income, add that to your total debts, and subtract it from assets. You will likely get a negative number that represents how much life insurance you need.
- 10 times your income. As it sounds, this method just takes your yearly income and multiplies it by ten to roughly estimate how much coverage you should have.
- 10 times plus $100,000. This uses the 10x your yearly income formula and adds an additional $100,000 per child for college expenses.
- DIME. DIME (debt, income, mortgage, and education) adds the following to determine how much life insurance you need:
- Debt and final expenses: Add up your debts, other than your mortgage, plus an estimate of your funeral expenses.
- Income: Decide for how many years your family would need support and multiply your annual income by that number.
- Mortgage: Calculate the amount you need to pay off your mortgage.
- Education: Estimate the cost of sending your kids to school and college.
What Is an Irrevocable Life Insurance Trust (ILIT)?
Life insurance can be a stand-alone component within your estate plan; however, many people choose to incorporate it into their funeral plan through the creation of an Irrevocable Life Insurance Trust (ILIT). An ILIT is a special type of irrevocable trust. Life insurance proceeds are typically included in the gross estate of a decedent, meaning the proceeds are included when calculating federal gift and estate taxes. An ILIT, however, owns the life insurance policy and the proceeds are paid out to the Trustee upon the death of the insured, taking advantage of a tax loophole that allows the proceeds to escape federal gift and estate taxes while also providing the funds necessary to pay for the insured’s funeral and burial. The trust can purchase a life insurance policy, or an existing policy can be transferred into the trust.
The terms of an ILIT can also be used to ensure that your wishes regarding your funeral and burial are honored through your appointment of the Trustee who is legally obligated to abide by the trust terms. You can be as detailed or as vague as you choose when creating your trust terms. Along with providing peace of mind, an ILIT removes decision-making authority from family members, relieving them of the stress that often results in family conflicts.
What Is a Senior Life Settlement?
When you reach your retirement years, you may decide to accept a “senior life settlement” which involves selling an existing life insurance policy to a third party (a company other than the company from which you purchased the policy) for more than the policy’s cash surrender value, but less than the net death benefit. For example, imagine that you have a life insurance policy with a death benefit of $5 million and a current cash surrender value of $1 million. A life settlement would give you more than $1 million but less than $5 million. You might, for example, be offered $2 million for the policy. The amount you are offered for your policy will vary from one company to another and will typically be calculated based on your policy premiums and your life expectancy. If you accept a senior life settlement, the third party would then take over the premium payments on the policy and receive the death benefit payout upon your death.
Contact Our Estate Planning Attorneys
For more information, please join us for an upcoming FREE seminar. If you have additional questions about life insurance within your estate plan in New Hampshire, contact our elder law attorneys in our North Andover, Woburn, and Beverly offices at (978) 969-0331. Our Salem and Nashua, New Hampshire office can be reached at (603) 894-4141.
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