Make the Most of Life Insurance

3.25.19Life insurance is the bedrock of many people’s financial plan. There are more nuances to life insurance, than just buying a policy and paying premiums.

It’s not the most fascinating topic, unless you’re in the business, but understanding the basics about life insurance can have big implications for you and your family, according to a recent article, “4 questions to ask to maximize your life insurance benefits” from WTOP. Here’s what you need to know about life insurance:

Changed Circumstances. The amount of life insurance you need, is unique to each person’s financial and family circumstances. Remember that life insurance death benefits are used for more than just replacing immediate income from the family breadwinners. They can also pay off the mortgage and other debts, cover college tuition, create a retirement nest egg for a surviving spouse, fund a business transfer, or be an important estate planning tool. With life insurance, you can protect your family against a premature death with a solid safety net. In the event of divorce with future child and spousal support obligations due to you, you’d want your divorce settlement agreement to say that your ex-spouse, as payor, maintains a sufficient life insurance policy naming you, as the recipient-beneficiary, to cover all future commitments. You also need to be notified by the insurance company of any policy changes or lapses because you may be depending on this money in the future, should something happen to your ex-spouse. Stay-at-home spouses and caregivers also need life insurance, because replacing their duties could incur many unexpected costs for the survivor.

Up-To-Date Beneficiaries. Here are some do’s and don’ts, when naming a beneficiary:

  • DO designate named individual(s) or a trust to avoid probate and allow death benefits to pass directly to beneficiaries, income tax-free;
  • DO know the difference between per stirpes (i.e., family lineage) and per capita (i.e., by head);
  • DON’T designate your estate, because this will lead to proceeds becoming involved in probate and allow creditors to place claims against the estate;
  • DON’T designate minors as beneficiaries, because assets will be paid outright to them as soon as they reach the age of majority in their state; and
  • DON’T designate a special-needs adult or child directly, because this may disqualify them from government benefits.

Trusts. Designating a trust as beneficiary for minor children, special-needs individuals, or a person with no financial sensibility lets you provide more control. Work with an estate attorney to establish the appropriate trust for your intended purpose. Remember, if you’re the trust owner and the insured, the death benefit will be included in your gross estate for tax purposes. Having life insurance owned by an irrevocable life insurance trust (ILIT) removes the death benefit proceeds from the insured’s estate (unless the three-year-look-back rule applies).

Policy Exclusions. Read the fine print to see if some of these universal exclusions are included, that may prevent your beneficiaries from receiving their intended death benefit:

  • The contestability period is a predetermined time period, usually two years from the date of issuance, where an insurance company can contest any information you submitted, and cancel coverage or deny a claim, if there were misstatements or omissions made on the life insurance application. If you die during the contestability period and it’s shown that you made misrepresentations on your application, your claim can be denied—even if the cause of death had nothing to do with the actual misrepresentation.
  • Material misrepresentation is intentionally withholding material information or providing false information to the insurance company, that would’ve resulted in them not insuring you. It extends during the entire policy term, since life insurance claims can be denied after the contestability period ends, if fraud was committed to obtain the policy.
  • A suicide clause is included in nearly all life insurance contracts. The company won’t pay the death benefit and return premiums, if the insured commits suicide within the first two years of the policy.

There’s a lot of fine print in your life insurance policy, and some of it is about exclusions that you need to be aware of. Most are things most of us don’t undertake: illegal activity/committing a crime; risky activities like sky diving or car racing; using alcohol and drugs; and an aviation exclusion for private plane travel. However, if those are pastimes that you or your spouse participate in, be prepared for your claims to be challenged.

Life insurance is like your estate plan. Both need to be updated, when there are big changes in your life. Speak with your estate planning attorney about whether or not there is a role for any insurance trusts in your estate plan.

Reference: WTOP (March 6, 2019) “4 questions to ask to maximize your life insurance benefits”

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