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3 Common Life Insurance Mistakes
(and how to avoid them)
By Gary Case

Published in the Idaho Press Tribune Sept. 17, 2010

This column is devoted to your personal and business life insurance. Each mistake has two things in common: first, potentially serious consequences in terms of both expense and aggravation; and second, each can be avoided or corrected quickly and inexpensively if found in time. The IRS does not care if you make these mistakes, but those who must make do with less or with nothing care deeply about them. Previous columns have outlined common life insurance mistakes. Here are others:

The amount of your personal coverage is inadequate for your family’s financial security goals. Who’s going to pay for your family’s food, clothing, shelter and education costs for the next X years? (Figure roughly that to raise a child through age 21— excluding college costs — the average cost exceeds $250,000, with about $70,000 for food alone!) Will those you love have enough after taxes, the payment of debts and other expenses to just go on living? If you haven’t recently checked, how do you know?

Obtain a no-nonsense insurance analysis of what you have and what your family will need if you die — and what you would need if you became disabled. A couple of hours with a competent professional may save your family’s financial way of life. Over and above all the amounts necessary to keep your family at the standard of living you feel is appropriate, consider having your spouse own and be beneficiary of life insurance equal to at least one year’s gross income on your life. This is what is often called a “Survivor’s Shock Absorber.” Psychologically, this “buys time” for the surviving spouse to adjust. He or she knows that — financially, at least — for one whole year nothing has to change and no snap decisions are necessary about moving or making radical adjustments in lifestyle.

 

Your policy is payable outright to your minor children or grandchildren. Improper disposition of assets is one of the most frequent and serious of all estate planning errors. It occurs when the wrong asset goes to the wrong person at the wrong time in the wrong manner. Equal is not necessarily fair. Perhaps your children have different needs. Should they all receive equal shares of your life insurance? Should they receive their shares outright? Are they currently mature enough to handle such a large amount? Are they sophisticated enough to invest it wisely? In many cases, state law will tie up those proceeds and make it expensive or time consuming for minor beneficiaries to use the money. Why? Because minors are under a legal disability. No insurance company will knowingly pay large amounts outright to minor children. So a guardian or custodian will have to be appointed by a court at your children’s expense to dole out their money to them.

Often, the best solution is to set up a trust for your spouse and children and name the trust as the recipient of your life insurance proceeds. You can build in a great deal of flexibility and sidestep a number of the legal restrictions imposed on outright distributions. This is a much safer and surer way to provide financial security for those who can’t or don’t want to handle large sums of money or other assets. A very cost-effective alternative, where the amount involved is more modest (or for any reason a trust is impractical or not desired), is to have the insurer pay out policy proceeds under what is called a “settlement option,” which provides a steady and consistent small amount of cash monthly over a long period of time.

 


Securities offered through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Investment Advisor Representative, Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Cambridge and Cornerstone Financial Planning are not affiliated.