As a divorced parent you may be questioning whether or not life insurance makes sense. Do you know how much insurance you may need? Or how much can you afford? Do you qualify for a policy? There are different types of insurance as well as different products. Let’s discuss life insurance and how it can be used to help protect your beneficiaries.
Many view life insurance as a necessity, protecting one from the “god forbid” situation. In the event that one or even both of the bread winners in the family were to pass away, how would your children or any of those you have provided for, financially survive. Have you saved for college? How will the mortgage on the home be paid for? As a divorcee, perhaps your ex is not around to provide, or can’t provide for the things you had planned on for your children.
On the other hand, life insurance is not always purchased to protect from the “god forbid” situation. Life insurance can be used as an estate planning tool as well. Upon your passing, your beneficiaries may be faced with a tax liability that would dramatically eat into the savings that you hoped would transfer to your beneficiaries. There are many uses for life insurance, and many people are not aware of the affordability of owning a policy.
How much insurance do I need?
There are mathematical calculations used to determine income replacement but more importantly you need to sit at the table and determine what you would want paid for if you were to pass away. Again, college for your two or three kids, the remainder of the mortgage, your child’s costs of living all add up to a large number, that perhaps you just have not attained as a balance in your current savings account. If you were not around can your children’s guardian afford to pay for the daily, weekly, monthly living expenses that you were capable of?
You determined how much insurance you need, but….
How much can I afford?
Getting a quote for an insurance policy is not as difficult as one might think. Filling out a basic questionnaire will return an approximate cost for a specific dollar amount of insurance. To get a firm quote one must undergo a basic medical evaluation. Once the exam is completed the insurance company will come back to you with an offer of coverage based upon the risk class rating you have been approved at. At that point you can determine what amount of coverage is affordable for you and move forward with having a policy issued and paid for, placing the new coverage in effect. The cost for life insurance is based on life expectancy, so the younger and healthier you are when you take out policy the cheaper it will be.
Types Of Policies
There are many different types of insurance policies, but let’s just focus on the two most commonly used.
The first is called Term Life Insurance. Term Life is a product that generally has a premium that remains level for a defined time frame, for example – 10, 15, 20 or even 30 years. You will pay an annual premium (can be paid semiannually, quarterly or monthly as well but additional fees may apply) and at the end of the 20 year time period the level premium period ends, and the coverage may continue with premiums that start to increase annually.
For example, Mrs. Jones takes out a $1 million 20-year term policy. She will pay the annual premium for 20 years and in the unfortunate event of her passing within the 20 year period, her beneficiaries will receive $1 million income tax-free. If she lives past the 20 year time period, the level premium period simply ends.
The second type of policy is called Permanent insurance. Permanent insurance comes in a few different types but one of the most commonly used is called Whole Life. Whole life is a policy that is designed to provide coverage for a long period of time, even for the rest of your life. Maximum ages to which coverage extends with today’s Whole Life products are age 121 or even “forever.”
When the policy begins, the annual premium you pay is divided into two portions. The first portion goes towards the insurance company’s costs but the second portion goes to a separate cash account (called the cash value) and acts like a savings account that you can borrow against (generally income tax-free) in case funds are needed for any number of reasons. As with Term, should you pass away while the policy is in force, your beneficiaries are paid the death benefit amount income tax-free. All types of Permanent insurance, including Whole Life, may be more expensive than Term Life and may not fit everyone’s available budget for coverage needed.
Once a Term or Permanent policy is in place, your only responsibility is to make sure the billed premium is paid and/or cash value is sufficient to ensure the policy does not lapse or default. Should you not pay the premium or the cash value is not sufficient, the policy will first enter a grace period (typically 30 days) and then lapse afterwards and become null and void. There is a short window to reinstate the policy should you lapse the coverage, but it is important to avoid putting yourself in that situation. You now have the insurance to cover the needs of your beneficiaries.
Funding Life Insurance
If you are newly divorced and as part of your divorce decree you are required to have life insurance, a financial advisor can assist in helping determine the best way to fund the annual premiums of your policy/policies. Taking assets that you may have received from your divorce settlement, investing them conservatively can kick off income that can be set aside for the annual insurance premiums. Make sure you have that conversation with an advisor.
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Greg Rosen is a Financial Planning Specialist and Financial Advisor, in Bedminster, NJ with the Global Wealth Management Division of Morgan Stanley Wealth Management. He is a licensed life, accident, health or sickness insurance provider. He can be reached at 908-306-8029.
The information contained in this article is not a solicitation to purchase or sell investments. Any information presented is general in nature and not intended to provide individually tailored investment advice. The strategies and/or investments referenced may not be suitable for all investors as the appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives. Investing involves risks and there is always the potential of losing money when you invest. The views expressed herein are those of the author and may not necessarily reflect the views of Morgan Stanley Wealth Management, or its affiliates Morgan Stanley Smith Barney, LLC, Member SIPC.
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Since life insurance is medically underwritten, you should not cancel your current policy until your new policy is in force. A change to your current policy may incur charges, fees and costs. A new policy will require a medical exam. Surrender charges may be imposed and the period of time for which the surrender charges apply may increase with a new policy. You should consult with your own tax advisors regarding your potential tax liability on surrenders.
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