Your House Is Going To Burn Down

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Posted: Oct 13, 2010 12:01 AM

“It is a strange anomaly that men could be careful to insure their houses, their ships, their merchandise, and yet neglect to insure their lives – surely the most important of all to their families, and more subject to loss.” --Ben Franklin

In the wonderful and whacky world of estate planning, life insurance plays a role that cannot be matched by any other financial instrument. Yet, no other financial tool is more misunderstood and maligned (usually by people who know what they’re talking about). So let’s set the record straight. It is all about time and money, and a life insurance policy provides both--when it is needed most.

Life insurance creates cash--instantly, often tax-free, at a time when it is most needed--like upon the death of a parent, breadwinner, business-partner, or key employee. It is that simple. It’s a pretty easy equation: Insurance creates cash; cash equals liquidity. Liquidity equals maneuverability. We don’t even need a calculator to do this kind of math. Cash can be used to solve a whole bunch of problems, such as paying bills, settling debts, and paying estate taxes (when they return--and they will return).

The best part about life insurance is that it represents money that you do not have now. It is a way “buy” future dollars at the cost of pennies on the dollar, otherwise known as premiums. Unfortunately, the topic deals with death, usually our own, and facing our mortality is often a difficult topic. Most people are not in a rush to discuss it, especially with insurance agents.

Life insurance buys time. Time is a valuable commodity in any estate plan. Over the last thirty years that I have worked in the estate planning field, I have had to be the delivery boy on some very large insurance death benefits. No one has refused the money. Please do not misunderstand what I am saying; there were plenty of heirs who would have gladly exchanged the insurance proceeds for the return of their parent or spouse, but they were grateful for the gift of time that insurance bought them.

The clock starts ticking on state inheritance taxes and federal death taxes as of the day of death. The state and federal governments want cash in nine months. Debts and other outstanding bills still require payment. If the life insurance proceeds are used to pay the taxes or pay off debt, it buys time to allow the transfer of assets to heirs without devastating shrinkage. Can you imagine if you needed to sell securities to pay taxes or debts over the last couple of years? How about needing to sell a home in this real estate market? Thanks to the liquidity created through the insurance proceeds, money invested in securities avoids liquidation in a down market. Real estate is not sold under the pressure of a ticking clock. Businesses are not sold at bargain prices. Pressure is replaced by peace.

Life insurance takes on different roles as we grow through life. Initially it is used to replace income if we should die as young adults with responsibilities of families, mortgages, and future educational costs. As we mature into business people, or professionals in practice, it is used to provide the capital necessary to fund business buy-sell arrangements. Eventually, our needs change to where insurance is used to provide the liquidity necessary to pay the estate settlement costs. Many people overlook this most powerful use, however, as a liquidity creator to pay estate taxes; it is often the best way to keep the estate intact.

You probably own a home. And, like every other homeowner, you own homeowner’s insurance. Homeowner’s coverage protects your investment from a multitude of potential losses. The greatest of these is the potential devastation caused from fire. Yet fires, catastrophes that they are, are not that common. Interesting, isn’t it? We spend thousands of dollars each year on insurance premiums for protection in case a fire occurs. Though the odds are slim that we will ever suffer a loss, we want to have the cash to rebuild if the unthinkable happens. What if you knew with absolute certainty that your house was going to burn down? You’d make damn sure the insurance premiums were paid. I wouldn’t doubt that you might be tempted to increase the coverage, even if it cost a little more.

Let me ask you a question. How many people do you know over the last ten years who had their home destroyed by fire? How many people do you know over the last ten years who died? I think you see where I’m going here. When it comes to life insurance, your house is going to burn down! There is no “if” here. Few things in life are guaranteed, this is one of them. Your family will suffer some kind of loss, emotional and/or financial. So why is there any question at all whether or not you should own life insurance? The only question should be how much?

Take the time and talk with a professional insurance advisor. One of the worst pieces of advice you’ll ever receive is that you do not need to maintain your life insurance as you get older. You may need to tweak it a little, but you need to get this point: you don’t out-grow it. The reality is that once you understand the role insurance plays in your legacy plan, you can’t own too much of it.