How Life Insurance Can Pay Essential Expenses

Here are some examples of the long- and short-term needs your family may encounter. To help minimize their worries, write up a plan with categories like these. Then, when the insurance proceeds are paid, your survivors will know exactly how to budget the money they'll be receiving from life insurance.

• Costs of death. Funeral, burial, and hospital bills ... these are the most common expenses that result from death. Life insurance proceeds reach your survivors quickly and are useful for dealing with these expenses. Your family should expect to pay $3,000 to $5,000 to cover such costs, more if the funeral arrangements are complicated or medical costs were high and not covered by insurance. See chapter 26 for more information on such expenses.
• Replacing lost income. You don't want your family to have to sell property to support itself in the absence of your paycheck. Nor do you want your working spouse to have to take a second job. Experts say a family needs 75% of its former after-tax income to maintain its standard of living after the principal wage earner dies.
  If you don't want your surviving spouse to have to work while raising the children, figure out how much it will take to support the family until the children are grown or at least able to care for themselves after school.
• Providing liquidity. Sometimes an estate largely consists of illiquid assets, such as a closely held family business or farm. An insurance policy can provide funds so that such assets don’t have to be sold to pay debts and expenses. Or an insurance trust (chapter 22) can buy such assets form the estate, thereby infusing the estate with enough cash to pay taxes and debts.
• Grief fund. Life insurance proceeds can support your family during the period of grief after your death so they don't have to go back to work too soon. This fund could equal up to several months of their normal income.
• Educational expenses. You can use life insurance proceeds (especially if paid into a trust) to set up a college fund for your children.
• Mortgage-canceling life insurance. Such a plan will pay off your mortgage when you die, so your survivors don't have to sell the family house. Or you can increase your life insurance by an amount sufficient to pay off the mortgage.
• Emergency fund. After figuring out the other needs, you might tack on two or three thousand dollars to help the family cope with unexpected emergencies.

Who should own the life insurance policy? If it's in your name, the proceeds payable on death (not the value of the premiums paid) will be included in your estate for estate tax purposes. That might force you to pay estate taxes if it pushes you beyond the federal tax limit. If the beneficiary is your spouse, the marital deduction (see chapter 20) will enable your estate to escape taxes on the value of the policy, though the proceeds may push your spouse’s estate over the limit, creating tax problems down the line. If someone else owns the insurance policy (commonly, a life insurance trust) the proceeds aren't included in your estate, enabling you to reduce its taxable value. In most cases, the recipient won't have to pay income taxes on the proceeds.