Anyone with a spouse or children but not a great fortune is wise to get life insurance. Often, a term policy is best, covering the family for 20 years until the kids are grown.
But what happens after that?
Typically, the policyholder hopes investments will grow large enough to cover needs after the policy expires, but that takes some effort and planning.
“It’s important to periodically revisit your life insurance needs,” says Paul Jacobs, chief investment officer of Palisades Hudson Financial Group in Atlanta. “It’s possible that the amount of coverage you need will increase, perhaps as your family grows or your income rises. As time passes and retirement comes closer, we often see life insurance needs shrink or disappear altogether, assuming that you have accumulated enough savings to protect your family and their lifestyle.”
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Life insurance comes in all shapes and sizes. A simple term policy can be very cheap and will pay a set death benefit if the policyholder dies before the term expires, which is typically 10, 20 or even 30 years if you start young enough. After that, the policy pays nothing.
Fancier “permanent” policies continue for life if premiums are paid. They can be much more expensive, but many have an investment, or cash value, that grows over time, can be withdrawn or borrowed, or used to pay premiums later in life.
But permanent does not always mean permanent. Some older permanent policies may actually expire at age 100, though 120 is more common today. After that, the policyholder is generally entitled to any cash value, but that may be less than the death benefit.
So it’s important to know how long your coverage will actually last, and to plan how to offset the death benefit after it lapses, if you’ll need to. People who take out term policies to protect children might find this happening in their 40s, 50s or 60s.
“Most people take out term life insurance when they get married and/or have kids so that if one of the parents dies the life insurance can provide money to replace money the deceased parent would have earned through working,” says Ed Snyder, a planner with Oaktree Financial Advisors in Carmel, Indiana. “If the end of your policy coincides with your kids leaving your house and becoming financially responsible for themselves, you no longer have as much of a need for that insurance.”
A policyholder who must plan to offset the expired death benefit can do so by increasing contributions to investments for other purposes, he says.
That need may arise, for instance, if the surviving spouse had opted to stay at home and would not be able to earn enough to make up for the income lost if the policyholder were to die after the policy expires.
Experts recommend policyholders consider several possible steps:
Figure the need. The first step would be to figure how large a fund the family would need to replace all or part of the expiring death benefit. Search for “retirement calculators” for tools that will show how much income a fund of a given size might produce, and how much would need to be saved to build such a fund.
Pedro Silva, a financial advisor at Provo Financial Services in Shrewsbury, Massachusetts, notes that if investments have grown and expenses like the mortgage and child-rearing costs get smaller it may not be necessary to replace the entire death benefit from an expiring term policy. But he adds that it’s also important to remember that inflation will chew at the value of both the death benefit and any replacement fund. Most retirement calculators factor this in.
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Consider new insurance. At some point, the couple may find the best option is to continue to pay for life insurance coverage. It may be possible, for instance, to extend the term policy for a higher premium and lower death benefit, or to take out a new one. An applicant in his or her 60s is likely to find that a new term policy will last only 10 years and will cost more than the 20-year policy taken out in his or her 40s, but it could be worth it if a death would be financially devastating to the survivor.
Jack Shinn, president of J. Shinn & Associates, a financial services firm in Glen Rock, New Jersey, says people seeking continuing coverage can get a permanent indexed insurance policy with an investment feature tracking a market gauge like the Standard & Poor’s 500 index. As with most investments, the younger you start the better.
Consider an annuity. A deferred annuity allows the policyholder to pay an upfront fee or regular premium and get an income for life starting some years later. Again, starting earlier, rather than waiting for the original term policy to expire, will assure a larger income.
Account for taxes. Because a life insurance death benefit is tax-free, a replacement investment may need to be even larger to have the same value after a tax bite. For most investors, capital gains and dividends are generally taxed at 15 percent, with interest earnings taxed at higher income tax rates.
Use the right account. A replacement fund can be built by opening a new account or increasing contributions to an existing one. Keep in mind that using a tax-favored account like an IRA or 401(k) will subject withdrawals to income tax. Also, the surviving spouse could face an early withdrawal penalty if he or she is not at least 59½ when money is taken out.
Whatever path you take, success will depend on planning and diligence, Snyder says.
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“Save as much as you can, as early as you can so that when you get 20 or 30 years down the road and that life insurance is gone, your family will have enough money to live on even if you die without life insurance and can’t earn any more money,” he says.
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Invest to Cover Life Insurance Gap originally appeared on usnews.com
