What is Life Insurance?
Life insurance is a legal contract. There are three roles in this contract. The first role is the owner of the policy, the second role is the insurer, and the third role is a beneficiary. Beyond these three basics roles, life insurance contracts vary widely in how they work and what purposes that they serve.
The owner of the life insurance policy is the person or entity that has the responsibility to pay the premium to keep the contract enforce. The owner can be the person on whose life is being insured, or it can be someone else that has what is called an “insurable interest”. An insurable interest is best thought as a risk of loss if the insured dies. If the owner is someone other than the person whose life is being insured, there must be some rational reason that they will suffer an economic loss as a result of the death. The other two roles are more straightforward as the Insurer is the company offering to issue the policy, and the beneficiary is the person or entity that receives the economic benefit of the policy upon the death of the insured, which is usually the owner.
There are many different types of life insurance policies, and each policy will have various limitations (or exclusions) for what the insurer will cover based on the risk factors. The risk factors of medical history, family medical history, and lifestyle choices (such as use of alcohol, smoking, or recreational drug use) will impact the cost of the premium and the amount of benefit that the insurer will be willing to take on. Remember, that the insurer must make sure that the policy is profitable for them and will price and limitation the benefit based upon the risk factors and will try to spread the risk.
What are the types of Life Insurance polies that are available?
The most common types of life insurance for estate planning are “term” and “whole life” insurance policies. Term life insurance has no investment value that is accrued, so the premiums do not build any value and only pay for the insurance coverage. As long as the policy premium is paid the term life insurance will provide death benefits for a specific period of time and may not be renewed if the person reaches a specific age. If the policy is terminated, there is no savings that will be paid. Term life insurance is useful when an economic benefit is needed for the insurable need for a set period, such as education for minor children, or to cover the cost of a debt/mortgage that needs to be paid at the time of death.
With “whole life” policies, the premium not only covers the cost of the risk of insurance for the persons' entire lifetime, but also builds value for the owner. There will be a surrender value that will increase over time, and eventually, the policy may accumulate greater interest and will pay for the premiums to keep the policy enforce.
There are also other types of life insurance, such as credit life insurance, accidental death and dismembership, preneed funeral policies. In general, I do not recommend credit life insurance or accidental death and dismembership insurance as they are not effective or the probability of pay out to the beneficiaries are very remote.
Why do people buy life insurance?
I find that people buy life insurance for the following purposes:
- Because they have a spouse and or minor children that they need the life insurance as a replacement for their lost earnings if they die unexpectedly.
- Because they have debt, such as mortgage on their home, that they want to make sure that the home is paid for and it they want to make sure that their spouse, or family have a home.
- Because they have a sufficiently large estates and they want to make sure that they their business, family farm, or other asset has to be sold to cover inheritance tax.
- Because the insured person is a key employee or business owner that has unique skills that their death will create an economic harm to other business owners, or the business entity would need liquidity to pay the decedent's estate a fair value for the decedent's share of the business.
What type of an asset is life insurance for estate planning?
Because life insurance has a designated beneficiary as part of the policy, it is almost always a non-probate asset, meaning that it will be handled outside of a formal or summary administration. However, if the named beneficiaries have predeceased the insured and there is no surviving contingent beneficiary named, then the insurer will pay the proceeds to the estate of the decedent, and it will require a court order.
Sometimes, a policy owner will intentionally name the beneficiary of the policy as the decedent's estate so that there is sufficient liquidity to settle his affairs. This has become a more popular approach since the federal estate tax limits have increased, and the person intends for his testamentary instrument to control how all of the assets are distributed or pay outstanding debts.
What if I lose my life insurance policy?
You need to notify your agent as soon as possible and ask for a replacement. It is very difficult for your beneficiary or your personal representative to claim the proceeds without the original policy. I strongly advise my clients to secure their life insurance policies with their original Last Will and Testaments or Revocable Trusts. Therefore, the life insurance may be held in the decedent's safety deposit box, home safe, or lock box to find out if there is a policy stored there.
The insuring company will ask for the return of the original policy, along with the proof of death, in order for the policy to be collected. If the original policy cannot be returned, an affidavit that the original policy has been lost.
Shawn can not offer legal advice in this format. He can only provide general information that you may find helpful. You should call an attorney and seek specific legal advice if you need legal guidance, you can rely on for your situation.
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