Strategies to Provide Adequate Resources for Survivors in the Event of Premature Death

As Benjamin Franklin bluntly put it, there are only two certainties in life: death and taxes. Since taxes can be avoided or at least minimized in some cases, this statement is not entirely true. Death, however, is inevitable. It’s only a matter of when each of us will die. Hopefully, you’ll live a long, fruitful life and be around until you’re 100 so you can tell your great-grandchildren stories about the good old days. Unfortunately, not everyone will be so lucky. For whatever reason, whether it be a terminal disease or a tragic accident, many of us die prematurely and unexpectedly. Your premature death may be a huge blow to your survivors for obvious emotional and psychological reasons. To make matters worse, it can also be financially devastating if appropriate planning strategies have not been implemented.

Example(s): Say that you’re 30 years old, happily married with three beautiful children, and have a great job earning over $100,000 a year. Life has generally been good to you so far, and the future looks even brighter. You’re also in perfect health, work in an office where the chances of a job-related injury or illness are remote, and keep your risky activities (such as hang gliding) to a minimum. Since the risk of your premature death seems so low, you opt not to purchase life insurance coverage on yourself. You reason: Why should I pay expensive premiums year after year for coverage that I probably won’t need for a long time to come? Also, since you’re young and perhaps somewhat unsophisticated about financial matters, you haven’t started saving for the future yet. You figure that maybe in 10 years or so you’ll start setting aside money for your children’s college education and your retirement needs. For now, you’d rather dine out every night, enjoy your money, and live the high life.

Example(s): Tragedy strikes, however, when you step out into the street one morning to begin your daily jog and get struck down by a speeding truck. Your spouse is grief-stricken. Lacking any marketable skills, he or she is also broke because you were the sole breadwinner in the household. Without any existing assets to draw on and without the life insurance coverage the two of you had talked about buying, your spouse is in serious financial trouble and now wishes you had taken steps to prevent this.

This is exactly the type of financial disaster to which your loved ones may be vulnerable if you haven’t taken the proper steps. If you have a spouse, dependent children, elderly parents, and other people you care about, their long-term financial security is probably very important to you. Although you’d like to be around for the long haul, you want to ensure that they will be able to meet their expenses and reach their goals even if something happens to you. Among other things, you want your spouse to have enough money to carry on and your kids to be able to attend college.

With such concerns in mind, there are a number of strategies you can make use of to provide your survivors with adequate resources if you die. The most common strategies available for this purpose are purchasing personal life insurance that enables you to transfer your risk to an insurance company, earmarking existing assets (i.e., self-insurance), and using government benefits. Whether you decide to use one strategy by itself or several, they can all help you protect your surviving loved ones from the kinds of financial losses they could suffer if you meet with an untimely end.

Strategies Available to You

Personal Life Insurance

Personal life insurance (as opposed to business use of life insurance) is the most commonly used strategy to combat the risks associated with premature death. This is because the funds triggered by government benefits might not be sufficient to provide your survivors with all the money they will need if something happens to you. Also, if you’re like most people, you probably don’t have enough resources to set aside assets for the future of your dependents.

Life insurance offers a relatively affordable way for the average person to obtain protection that might otherwise be unavailable.

When you purchase a life insurance policy, you enter into a kind of contract with the insurance company behind the policy. While you can terminate the contract (cancel the policy) anytime you choose, the company will generally be obligated to hold up its end of the bargain as long as you hold up yours—if you pay all your premiums on time and fulfill other contract requirements, the company will have to come through with the specified amount in death benefits for your designated beneficiary(ies) if you die. The contractual arrangement between you and your company allows both sides to take advantage of risk pooling.

If you choose to take out life insurance, you need to pick a good insurance company and agent, select the right policy that provides the right type of coverage, and decide on an appropriate level or amount of coverage.

You also need to review the policy periodically to determine if your circumstances warrant any changes.

Finally, you should familiarize yourself with life insurance terminology and with some of the basic concepts and issues that apply to life insurance.

Transfer Risk to Insurance Company

The idea of risk transfer forms the basis of most life insurance policies. Although you can never eliminate or remove risk altogether, a life insurance contract allows you to shift the risks associated with premature death to your insurance company. Being a large institution, your company is in a much better position to shoulder the individual risks that you could not cope with by yourself. The company assumes the risks of many different individuals and is therefore able to take advantage of the law of averages through risk pooling. Over the course of a given year, it collects a great deal of money in premiums and then pays death benefits for the few policyholders who die. The company generates profits this way, while you minimize your personal risk by sharing it with the company’s many other policyholders. (This concept is known as the “Law of Large Numbers”.)

Earmark Existing Assets (Self-Insure)

While most of us complain about the cost of our life insurance, we still keep it because we need the protection. In some cases, however, it may be appropriate to forgo life insurance or to cancel your existing policy. Specifically, if you have adequate resources, you may be in a financial position to adopt a strategy of self-insurance in lieu of life insurance. Self-insuring involves setting aside a portion of your existing assets for the future of your surviving dependents. If you can afford it, this strategy may not require that you lower your standard of living and will give you the comfort of knowing that your loved ones will have access to the designated funds if something happens to you. The amount that you earmark for this purpose should generally be equal to the amount of death benefit coverage you would need if you had life insurance.

Another way you can self-insure is by setting up a savings plan to accumulate funds that your loved ones will be able to draw on if you die (an automatic investment plan is one option). While this strategy offers a viable option for the less wealthy, it generally carries greater risk than the earmarking strategy because of the long time it may take to build assets of substantial value. If you unexpectedly die after having saved only $1,000, your survivors will be hard-pressed to meet their expenses and attain their financial goals. If combined with a decreasing term insurance policy, this is less risky. In any case, whether you self-insure by earmarking or by saving, you should invest the assets wisely so that they grow. Also, be aware that self-insuring may have potentially serious estate tax consequences.

Depending on your age, health, and other factors, you may be uninsurable altogether or at least uninsurable at standard rates you can afford. If so, self-insuring may be one of your only options if you want financial protection against the risk of premature death.

Use of Government Benefits

Government benefits may also provide funds to your survivors. If you are either fully or currently insured under the Social Security system, your survivors may be entitled to both Social Security survivor’s benefits and the lump-sum death benefit. With survivor benefits, you earn credits toward the benefits by paying Social Security taxes. The dependents that may qualify for these benefits include your spouse, your former spouse, your children, and your parents. The amount that each type of dependent can receive will be based on your average lifetime earnings and a combination of other factors. The lump-sum death benefit is a one-time payment of a maximum of $255 that is generally payable only to a surviving spouse and/or dependent children.

There are other types of government benefits for which your surviving dependents may or may not be eligible when you die. These include retirement programs for federal and state employees, military benefits, Railroad Retirement System benefits, and workers’ compensation benefits.

Government benefits are relatively small in most cases and are generally subject to restrictions (e.g., your spouse generally will not be able to start collecting Social Security survivor benefits until he or she reaches age 60). Given these limitations, you probably shouldn’t assume that government benefits by themselves will supply your surviving dependents with sufficient resources if you die prematurely. Generally speaking, you should think of government benefits as a source of additional funds that will supplement the financial protection provided by other strategies, such as personal life insurance and self-insuring.

If you have questions, contact the experts at Henssler Financial:

• Experts Request Form
• Email: experts@henssler.com
• Phone: 770-429-9166