Life insurance proceeds may be received under four basic options: (1) interest-paid for a limited time and then another option is selected, (2) fixed period-equal installments paid for a fixed period at a guaranteed rate, (3) fixed income-fixed payments for a specific period after which the balance is payable under some other option, or (4) life income-an annuity for life. The choice basically is a gamble, and once made, involves rigidity not present in a trust. An insurance specialist should be consulted to arrive at the choice best for meeting the individual’s objectives.
Replacing Policies in Force
Replacing policies in force rarely is advisable due to new acquisition costs, policy value increases with age, a contestable period, unequal dividends, unequal cash value, and replacement by policies of a different type. Especially if the amounts involved are substantial, an insurance consultant-whose fee is dependent on the service provided, not the sale of a particular insurance product-should be consulted.
How Much Insurance is Enough?
The choice of how much insurance to purchase is highly subjective, but there are some guidelines that can be followed in reaching a logical, affordable, and common sense decision. Rules of thumb such as the 10-times-earning rule should be avoided.
Insurance should be concentrated on the person who generates the family income, since it is this income stream that needs to be replaced if the person dies prematurely. First, information about the family assets and liabilities and the family estate plan should be assembled-that is, an inventory of family resources. What are the family goals and aspirations? Then, the net value of the assets and liabilities should be projected for a reasonable planning horizon. A 5-year horizon should be sufficient, but not more than 10 years, since anything over 10 years is pure guesswork. The effects of the untimely death of the primary breadwinner should be calculated considering factors such as family income needs due to the loss of his (her) salary and leadership, estate taxes, administrative costs, and funeral expenses.
The status of liquid funds needed to maintain the family’s expected standard of living should be evaluated. What are the family’s goals for shelter, college, retirement, and recreation? With regard to the continuity of business, do family goals involve acquiring more forest land or better management of what already is owned?
The process of determining the needs of the immediate family is illustrated conceptually in figure 10.1. How much insurance is needed to protect the family if the priily goals are met? The answer depends on where the family is on the time line. If the available resources are insufficient to meet the goals, there are three basic courses of action: (1) increase earnings, (2) reduce costs, or (3) redefine goals. Insurance can fill some of the gaps.
Life insurance policies should be reviewed periodically to evaluate whether they are providing adequate coverage at affordable cost. The concerns outlined above also should be revisited periodically: What are the resources? What are the goals? Can the resources (forest land, timber growing stock, and capital) be increased to produce the income (growth) that is needed to meet family goals? Insurance is one alternative to bring income protection up to the minimum level desired to assure a particular standard of living.
In the event that premiums are not paid in a timely manner, most permanent insurance provides for a period of extended coverage as term insurance. This generally is not the preferred method for adjusting coverage. If the owner decides to stop paying the premiums on the policy, paid-up insurance can be obtained instead of cash.
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To avoid the problem illustrated above, all “incidents of ownership” should be divested 3 years or more prior to an insured’s death. Incidents of ownership include the power to: (1) change the beneficiaries of the policy, (2) cancel the policy, (3) assign the policy, (4) pledge the policy for a loan, or (5) borrow against the policy’s cash value. Reversionary interests, by which the insured may regain one or more of these rights in the event a beneficiary predeceases the insured, or if certain other contingencies occur, should not be held. Additionally, the insured should not pay the premiums on the policy after giving up ownership. Gifts of cash or income-producing property to the policyholder on the insured’s life should not be in amounts or timed so as to have the appearance that the insured is supplying funds for the premiums.