Earlier this year, a California tech billionaire set a new record, buying a life insurance policy with the highest death benefit ever: $201 million. The policy was so big that the advisors working with the billionaire had to split the policy between 19 different life insurance companies, so that none of them would bear too much risk from a single person's life. Given the estate planning challenges that the ultra-wealthy face, a policy that big could be a big win for the billionaire's entire family.
Of course, you probably don't need $201 million in life insurance. But most people face the same types of financial risks on a smaller scale, and therefore, having life-insurance protection often makes sense. But people often get confused about life insurance and how to make sure that you get the policy that's right for you and your needs. With that in mind, let's take a look at five lessons that you can take to heart from this billionaire's experience.
1. Buy the right amount of life insurance.
When you're buying life insurance, one key decision is how large a death benefit you want your family to get. The right death benefit will depend on the financial needs of your family, including paying off a large mortgage after your death or ensuring that your spouse and children will have enough financial resources to take care of their needs if something happens to you. Moreover, bear in mind that you can't necessarily count on getting additional coverage later, as health changes can make you uninsurable for new policies while still letting you retain policies you bought prior to an adverse health condition. Therefore, it's smart not only to consider your current needs but also to anticipate future increases in those needs.
2. Make sure you use life insurance companies you can trust.
Shopping for life insurance based on price is a natural thing to do, but in some cases, you do get what you pay for. Some insurance companies offer lower-priced policies because they're not as well capitalized as their competitors, and therefore have weaker ratings from agencies like A.M. Best for financial strength. In exchange for saving minimum amounts on your annual premiums, going with cut-rate life insurance companies can put your family at risk of not being able to collect on your policy after your death. Guaranty associations provide some measure of protection from life-insurance company insolvency, similar to what the FDIC does for bank accounts. But limits can be relatively low, and so you might not get the full coverage you'd expect.
3. Look into special life insurance strategies.
If you're rich enough to need to consider estate taxes, how you own your life insurance can make a critical difference. Owning a policy in your own name means that the proceeds will be included in your taxable estate, and therefore be subject to taxes at rates up to 40% if your total assets exceed the lifetime exemption threshold. If you own a policy through a life insurance trust, however, the proceeds won't be included in your estate, and that can make sure that more of your life insurance payout goes to your family and less goes to the IRS.
4. But be careful of investment-related life insurance products.
Insurance products have special tax advantages that are similar to what retirement accounts offer, in that investments within life insurance products grow on a tax-deferred basis until they actually pay out benefits. As a result, many advisors recommend investment-linked life insurance policies to take advantage of prospective tax savings. However, those investments can be complex, and the fees involved can add substantial annual maintenance costs to sustaining your policy. Some life-insurance investments can be valuable, but in many cases, you'll do better investing elsewhere and keeping your life insurance policy as simple as possible.
5. Revisit your life insurance needs from time to time.
Life insurance is intended to protect your family from the financial consequences of your death. But at some point, your family won't need as much protection, and at that time, it makes sense to revisit whether you really need to retain your life insurance. For instance, once your children are grown, then you won't need to worry about the expenses involved in raising them if you die. Similarly, as your retirement assets grow, your spouse might not need as much financial protection from third-party life insurance companies, instead relying on your own family savings.
Life insurance can be tricky, but that doesn't mean you should just ignore the financial risks you face. By keeping these five lessons in mind, you can make sure your insurance coverage does the job for you and your family.
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