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Leaving loved ones with a legacy of debt is dumb – you need a safety net

by Susan Wright | Contributor
April 20, 2020

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With longer life expectancy today, it is possible that you could spend 20 or more years in retirement. Because of that, more retirees are opting to “take the plunge” and are moving to new homes or condos and in turn, taking on additional mortgage debt.

But if you fall into this category, even though you may be able to make your new monthly mortgage payments on time, how much debt would you leave behind if the unexpected occurred sooner rather than later?

Could your loved ones handle their own debt and yours?

With a roller coaster stock market and employment uncertainty – due in large part to the COVID-19 pandemic – household debt in the United States climbed to an all-time high at the end of 2020.

This debt surge has been fueled in large part by retirees who are now moving into their “golden years” burdened with debt – and not all of this debt is the result of making food and other necessary purchases.

In fact, more than $10 trillion of it came from mortgages, with roughly $183 billion in housing-related debt coming in the last quarter of 2020 alone. One reason for this was the historically low interest rates that made money much “cheaper” to borrow.

But even so, if you’ve got a six- or possibly even a seven-figure debt balance on hand, could your survivors continue making these payments if the unexpected occurs?

And if not, how would this debt obligation impact their lives?

Consider this – if you or your spouse were to pass away, it is possible that at least some of your household income would also disappear. For instance, if you’re one of the few remaining recipients of an employer-sponsored defined benefit pension plan, it is likely that these income payments would be reduced – or would possibly even disappear altogether – upon your death. If that happened, would your surviving spouse or partner be able to continue paying their living expenses?

Likewise, if a couple is receiving Social Security retirement income benefits, a portion of these would also go away upon one spouse’s death. As an example, Joe and Peggy are both age 67. Joe has recently retired, and based on his work record, he receives $2,000 per month from Social Security.

As a stay-at-home mom, Peggy qualifies for a monthly spousal benefit from Social Security in the amount of $1,000. So combined, Joe and Peggy generate a total of $3,000 per month from their Social Security benefits.

Upon the death of the first spouse, though, the survivor will retain the higher of the two incomes – in this case, Joe’s benefit of $2,000 per month. But the lower income benefit will disappear.

This means that when Joe or Peggy pass away, the surviving spouse will lose $1,000 per month from Social Security – and this income reduction could make a considerable dent in the survivor’s budget going forward, especially if they have recently taken on additional debt.

Without a way to “replace” that $1,000 per month, the surviving spouse may have to make some significant changes in their lifestyle – which could include moving to a more affordable home (or possibly even moving in with an adult child or other loved one).

Given that, building in a financial “safety net” that can replace lost income is an essential component of most any good solid retirement plan. One way to do that is through the purchase of life insurance.

Why life insurance can fill in many financial “gaps”

As household debt soars, life insurance protection is more important than ever before – regardless of your age or income level. While most people don’t relish the idea of discussing their life insurance needs, the truth is that this flexible financial tool can provide solutions for a number of different financial obligations. For instance, the death benefit proceeds can provide an immediate lump sum of cash that could be used for one or more of the following:

  • Paying for funeral, burial, grave marker and other final expenses
  • Replacing lost income
  • Eliminating debts – including a home mortgage, vehicle loan and/or high-interest credit card balance(s)
  • Paying for a loved one’s future college education
  • Making charitable donations

In addition, there are other benefits that life insurance could provide, as well – even while the insured is still alive. For example, the accelerated death benefit is a provision that is found in many life insurance policies today.

This feature allows the insured to access a portion of the death benefit early – to be used while they are still alive – for payment of various health care costs, long-term care needs and other qualifying conditions.

Given the wide range of policy features and optional riders, determining the right life insurance coverage for your particular needs can be somewhat challenging – that is, unless you have a guide who can assist you with narrowing down the best option for you.

Which type of life insurance policy is best?

There are many different variations and configurations of life insurance coverage. But even so, there are just two main categories of protection. These are term and permanent. Term life insurance is considered to be the most “basic” type of plan. It offers pure death benefit protection, without any cash value or investment build-up.

As its name suggests, term life insurance will only remain in force for a certain period of time, or “term.” The time frame may be as short as just one year, or as long as 30 or more. But in any case, unless the policy is converted into permanent protection, term life insurance will eventually expire – and if the insured wishes to renew the coverage, the new premium going forward will be based on his or her then-current age and health condition. (If the insured has contracted a serious health issue, it is possible that they will be uninsurable.)

This is why term life insurance is typically only recommended for “temporary” coverage needs and/or for those who are seeking a large amount of coverage at a low premium rate for a pre-set period of time.

Alternatively, a permanent life insurance policy can last for your entire lifetime. Typically, once the coverage is “locked in,” it cannot be cancelled by the insurance carrier – provided that the premium is paid.

This form of life insurance coverage can be a good solution for long-term financial needs, such as income replacement and/or long-term debt payoff. In addition, if you contract an adverse health condition while you are covered, your permanent policy will still remain in force.

Permanent life insurance policies also include a cash value component where funds grow tax-deferred. This means that there is no tax due on the gain unless or until the money is withdrawn. Taking cash from your policy could allow you to pay off other debts and/or to supplement your future retirement income.

There is also a way to access funds tax-free from a permanent life insurance policy. This can be done through a policy loan. Going this route can allow you to spend 100% of the funds that you access.

Term vs. Permanent Life Insurance
Term Life Insurance Permanent Life Insurance
Coverage duration Temporary Permanent (as long as the premium is paid)
Premium Lower initially; increases upon renewal Higher initially; then typically remains the same
Cash / savings component No Yes
Benefit payment Benefit paid at death to beneficiary Benefit paid at death to beneficiary; may also offer living benefits, withdrawals and/or loans from the cash value component

While interest will typically accrue on the unpaid loan balance, if it is not repaid in full, the death benefit proceeds will go toward the loan payoff at the time of the insured’s passing. The named beneficiary (or beneficiaries) will then receive the remainder of the proceeds.

As an added bonus, interest will continue to compound on the policy’s cash value as if the amount that was borrowed was still there. This is because the loan is technically from the insurance company, and the policy’s cash value is simply used as collateral.

Given its long-term protection and tax-related advantages, permanent life insurance can be used not only for paying off debts and replacing income, but also to provide a legacy for your loved ones. >

How big of a financial safety net do you need?

So, just how much of a financial safety net do you need?

The answer to that can depend on several factors – starting with whether or not you have dependents who will have to either continue paying on your home mortgage (and other debts) or drastically change their lifestyle.

Even if you don’t have a home mortgage, what other types of household debt do you carry?

According to a recent study by Equifax and the New York Fed Consumer Credit Panel, as of year-end 2020, debt in the U.S. was rising in several different areas, including:

  • Home equity lines of credit
  • Auto loans
  • Credit cards
  • Student loans

A life insurance needs calculator can help you to determine an appropriate amount of coverage for your specific short- and long-term objectives. Working with a life insurance specialist can also be a good solution for coming up with the right coverage amount, as well as for adding any additional coverage – or “riders” – to the plan so that it can be more customized to fit your specific situation.

Will you qualify for life insurance?

Although life insurance can provide your survivors with a way to pay off debt and/or replace lost income, not everyone will qualify for coverage. Typically, a life insurance application will ask questions regarding your age, health and occupation.

Other information that is usually required before an insurance company will approve you for coverage includes:

  • Smoking status (this includes cigarettes, cigars, chewing tobacco and marijuana use)
  • Prescription medications taken
  • Health history and family health history
  • Hobbies (such as rock climbing, surfing, etc., that could pose injury or death)
  • Other life insurance coverage in force

Depending on the type and amount of life insurance coverage you are applying for, it is possible that you may also have to take a paramedical examination. This exam usually entails meeting with a medical professional who will ask you more in-depth health-related questions. They will also ask you to submit a blood and urine sample.

These are then analyzed for various health conditions that could pose a high risk to the insurance carrier. Your primary care doctor may also be asked to submit your medical records for review by the insurance company’s underwriters.

Because insurance companies want to hedge their risk, the underwriters typically take a close look at the health and health history of applicants before giving approval (or denial) for a policy. If an applicant possesses serious health issues like heart disease, it is possible that coverage through a fully underwritten plan will be denied.

In this case, there may still be other options that are available. One possible solution could be a guaranteed issue life insurance policy. With this type of coverage, you are not required to answer health questions or undergo a medical exam.

In fact, as long as the premium is paid, you will likely qualify for this type of life insurance coverage. It is important to note, though, that due to the high risk to the insurance carrier, the premium for guaranteed issue life insurance is generally higher than a fully underwritten plan that offers the same amount of death benefit. The dollar amount of the death benefit proceeds is usually capped at a low amount, as well. For instance, many of these policies have coverage amounts of $25,000 or less.

In addition, there is oftentimes a waiting period on the death benefit payout with a guaranteed issue policy. For instance, if the insured dies within the first two years that the policy is in force, only a portion of the death benefit proceeds will be paid to the beneficiaries.

Talking over your life insurance needs with a specialist – as well as any potential obstacles for obtaining coverage – can be beneficial, particularly if the financial professional is able to go out into the marketplace and find the right match for you.

What if your situation changes?

If you already have life insurance in place – or if you plan to purchase a policy in the near future – it is important that you regularly review your coverage in order to ensure that the type and amount of the benefits is still in line with your objectives.

In most cases, reviewing your plan on an annual basis – along with your retirement income and other financial strategies – is recommended. However, if you have encountered any major life changes, a life insurance review should take place at that time.

Some events that could have an impact on the amount of life insurance you’ll need going forward can include:

  • Marriage and/or divorce
  • Death of a spouse or partner
  • Birth or adoption of a child or grandchild
  • Retirement
  • Purchase or sale of a business
  • Buying and/or selling a home

Taking a look at your current needs can help you to attain and maintain enough benefit proceeds. In addition, it can better ensure that you won’t unintentionally disinherit a loved one (such as a new family member). Just as important, a regular life insurance review can also help you make sure that someone you no longer wish to receive any proceeds will benefit (such as an ex-spouse) from your coverage.

How can you put the right type of protection in place?

The days of remaining in the family home until it is paid off are over. More and more retirees are selling their current homes and buying new ones – and they are financing them with hefty mortgages. So, getting a financial safety net in place is an essential component of your retirement plan.

But making sure that you have the right type and amount of financial protection in place can seem a bit overwhelming. There are many items to consider – and you want to make sure that you have all of the bases covered. It is also important that your coverage will remain in place, and that it “grows” with you as your needs change over time.

That’s why it is important that you discuss your protection needs with a life insurance specialist who can determine what type of life insurance is right for you, as well as determine an appropriate amount of proceeds.

Talking through your situation with an Alliance America financial professional can help. At Alliance America, we specialize in life and income planning. We know that retirement is much more than just having enough money to get by on. That’s why our strategies start with your goals in mind.

Alliance America can help

Alliance America is an insurance and financial services company. Our financial planners and retirement income certified professionals can assist you in maximizing your retirement resources and help you to achieve your future goals. We have access to an array of products and services, all focused on helping you enjoy the retirement lifestyle you want and deserve. You can request a no-cost, no-obligation consultation by calling (833) 219-6884 today.

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