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May 14, 2005

Getting Organized for Heirs

Even if you have a formal estate plan, organizing your personal paperwork and informing heirs of basic decisions will make it easier for heirs to handle your estate after your death.

Without an organized approach, your preferences for funeral arrangements may not be followed, friends or family may not be notified of your death, or items with sentimental value may not be properly passed on. Without organized financial records, your heirs may not locate all assets, with the possibility that stocks, bonds, bank accounts, real estate, or insurance policy benefits may go unclaimed.

One way to approach this task in a systematic manner is to prepare a personal letter of instruction, covering the following topics:

  • Your assets and rationale for distribution. This is a good place to explain why you distributed your estate in the manner you did. You can go into specific detail, informing heirs how each asset will be distributed, or you can give a general overview of your estate plan. If you selected one heir as executor or trustee, explain why you chose that individual. List all assets and where important documents concerning those assets are located. Prepare a list of all checking and savings accounts, including the bank name, account numbers, and individuals on the account. Detail all insurance policies, including policy numbers, effective dates, levels of coverage, and policy location. Also list all outstanding debts.

  • Individuals to contact. List names, addresses, and telephone numbers of individuals your heirs may need to contact, including employers, attorneys, accountants, insurance agents, investment managers, and financial planners.

  • Personal papers. Indicate where personal records are kept, including your birth certificate, marriage certificate, divorce or separation agreements, diplomas, military records, and naturalization records.

  • Safe deposit box. Indicate where the safe deposit box is located and what is contained in the box. Note where the key is kept and who has access to the box.

  • Disposition of personal items. Detail how you would like personal items distributed, including jewelry, photographs, personal collections, pets, and furniture.

  • Funeral arrangements. Indicate your preferences for funeral arrangements, including whether you want a religious or secular service, whether you want flowers or donations to charity, whether you want to donate your organs or body to medical institutions, and where you would like to be buried or how your remains should be disposed of. These are items your heirs may feel uncomfortable asking about, but will be grateful your wishes are known so they can carry them out. Also list any friends or family you would like contacted after your death.
Your thoughts on these subjects can change over time, so review and update the letter periodically. Keep it in a place where heirs can find it immediately after your death.

Reevaluate Your Life Insurance at Retirement

As retirement age approaches, it’s usually a good time to reassess your life insurance policies, since your needs may change then. With your children on their own and no earned income to replace, you may no longer need a large life insurance policy. Especially if your insurance premiums are high, you may be tempted to cancel the policy, take the cash surrender value, and enjoy retirement. Before you do so, make sure there aren’t other uses for your life insurance policy. Some possibilities include:

  • To leave a legacy to heirs: Many people like the thought of leaving a large sum to their children or grandchildren. With an insurance policy in place, you can feel free to spend your retirement assets during your lifetime, knowing the insurance policy proceeds will be paid to your heirs after your death. If you have a large estate, the policy proceeds can be used to help pay estate taxes.

  • To pay for college for grandchildren: With the rapidly increasing costs of college making it more and more difficult for parents to cover this cost, you might want to use an insurance policy as a college fund for your grandchildren. If you’re still alive when they start college, you might be able to borrow some of the cash surrender value to pay these costs.

  • To support adult children: There are a variety of reasons why you might want to provide financial help for an adult child. Perhaps your child is a doctor, but has significant debt from college. Or your child might work at a profession that doesn’t pay much.

  • To provide a large charitable contribution: A life insurance policy can serve a couple of purposes when making a large charitable contribution. You can name the charity as the beneficiary of the policy. Or you can leave other assets to the charity that would have been included in your estate and possibly be subject to estate taxes. The proceeds of the life insurance policy, if properly structured, can then be paid to your heirs estate and income tax free.

  • To help deal with long-term-care costs: Many individuals don’t purchase long-term-care insurance, believing their spouse will care for them. However, when one spouse dies, who will take care of the other spouse? The proceeds of a life insurance policy can be used to provide long-term care for the surviving spouse.

  • To optimize pension benefits: When retiring, irrevocable decisions about benefit payments from pension plans must typically be made. An individual life income option will pay higher benefits than a joint and survivor benefit, but then your spouse will not have pension benefits if you predecease him/her. You could use the proceeds of the life insurance policy as a source of income for your spouse after your death.

While it is generally believed that life insurance needs decrease after retirement, there are a variety of reasons why you might want to retain your life insurance policy.

How Much Life Insurance Do You Need?

This is a subject that most people would just prefer to ignore. After all, it requires you to face your own mortality and then make some hard decisions about how you want to provide for your family after your death. A recent study found that 39% of surviving families did not have any life insurance. Of those who had insurance, the average amount was just 2.1 times personal income. Thus, two-thirds of surviving spouses felt that there was a devastating or major impact on their family’s personal situation after their spouse’s death (Source: National Underwriter, July 5, 2004).

Many rules of thumb indicate how much life insurance you should purchase, such as five to seven times your annual income. While that might sound like a lot of insurance, it may actually understate your needs. In order to distribute the Victim’s Relief Fund to surviving families of those lost on September 11, the U.S. Department of Justice estimated the economic loss for individuals, based on various ages, incomes, and number of dependent children. Their tables calculated settlements ranging from four times to as much as 50 times income. For instance, the loss for a married 40-year-old with two minor children (newborn and nine years old) earning $150,000 annually was calculated as $2,822,558 (Source: U.S. Department of Justice). From those figures, other income sources were deducted, such as government benefits, investments, etc.

Thus, when calculating your life insurance needs, don’t focus on rules of thumb. Rather, go through a detailed analysis of your insurance needs. In addition to the loss of your income, address issues such as:

  • What standard of living do you want to provide for your dependents? Do you want to provide the same standard of living, including things like vacations and club memberships?

  • Do you want to provide college education for your children?

  • If your spouse doesn’t work, do you want that lifestyle to continue or do you expect your spouse to work after your death? If you expect your spouse to work, what is a reasonable amount of income to expect him/her to earn?

  • Do you need to consider the support of elderly parents or other relatives?

  • How long must your family live off the insurance proceeds? Will your current retirement fund provide enough income for your spouse to live on after retirement, or do you need to provide income until his/her death?

  • Do you want to pay off a mortgage or other debt with insurance proceeds?

  • Do you have estate tax considerations that you want to address with life insurance?

  • Have you factored in a reasonable rate of inflation?

Once you have thought through these issues, you can calculate an amount of life insurance that will help you achieve these goals.

Coming to Grips with Life Insurance

Life insurance is one of those things you know you should pay more attention to, but can never seem to get around to doing. Part of the reason is an unwillingness to deal with our own mortality. But the vast array of insurance choices also makes it difficult to make decisions. To help overcome these obstacles, consider these five points:

  1. Do you really need life insurance? The most common reason for purchasing life insurance is to ensure your family can maintain their standard of living after your death. Generally, your life insurance needs will be highest after you start a family and will decrease over time as your children grow and become independent.

    However, life insurance can also serve other important purposes. If a major portion of your estate consists of illiquid assets, life insurance can provide funds for heirs to pay estate taxes without liquidating those assets. Even though the estate tax is scheduled to be repealed in 2010, it will be reinstated in 2011 unless further legislation is passed. You may also want to leave a large inheritance to heirs or a charitable contribution through life insurance proceeds. Business owners often use life insurance to buy out a deceased partner’s heirs or to provide funds to pay estate taxes so the business does not have to be sold.

  2. How much life insurance do you need? Various rules of thumb exist, such as purchasing five to seven times your current income, but they don’t consider your personal situation. The amount of life insurance you need depends on your current net worth, the lifestyle you want to provide for your family, and other personal needs and desires.
  3. What type of insurance should you purchase? There are two basic types: — Term Insurance and Permanent Insurance. Term Insurance provides protection only, with none of the premium set aside to build cash value. If you die during the policy’s term, your beneficiary receives the policy’s proceeds. However, you get nothing if the policy is canceled. Click here to compare Term Insurance Rates.

    Permanent Insurance accumulates, from premiums paid and investment earnings, a cash surrender value that is returned to you if you surrender the policy. Also, you can borrow the cash value through policy loans, although outstanding loans reduce the insurance proceeds when you die.

    Carefully assess which type of insurance is preferable for you. When you are younger, term insurance premiums tend to be lower. However, the premiums typically increase over time. If you are insuring a need that is likely to go away, such as providing a standard of living for minor children, then term insurance may be more appropriate. Those insuring a permanent need, such as providing funds to pay estate taxes or to maintain a standard of living for a spouse, may want to consider permanent insurance. .

  4. How do you compare individual policies? Since life insurance companies offer so many different options, it can be difficult to compare several policies. Try following these steps:

    Compare only the same type of policy. For instance, don’t compare a term policy to a variable life or whole life policy.

    Make sure the policies contain the same options and riders.

    If considering permanent insurance policies, review the assumptions used in the policy illustration, which shows the policy’s projected value at some time in the future. Keep in mind that these illustrations are hypothetical and your value will depend on the policy’s actual performance. Obtain illustrations based on three alternatives: 1). the original illustration; 2). one with an interest rate 1% lower than anticipated; and 3). one with the minimum guaranteed rate.

  5. How do you assess the insurance company’s financial strength? Since you may not receive benefits for many years, you should assess the insurance company’s financial strength before purchasing the policy and periodically thereafter. A good place to start is with the ratings assigned by rating organizations, reviewing the ratings of at least two organizations. Familiarize yourself with each organization’s rating systems, since the same grade from different organizations can mean different things.

A life insurance policy should be a long-term commitment, so spend the time up front to ensure you purchase a policy that adequately meets your needs.

What Are Health Savings Accounts (HSAs)?

Effective starting in 2004, Health Savings Accounts (HSAs) provide a way to help save on medical costs.

To qualify, you must be covered by a health insurance policy with a minimum deductible of $1,000 for individuals and $2,000 for families in 2005. Maximum out-of-pocket costs for the medical insurance plan, including deductibles and co-payments, must not exceed $5,100 for individuals and $10,200 for families in 2005.

If your plan meets those requirements, you can then set up an HSA account, where you can deposit pre-tax dollars up to your deductible each year. In 2005, these amounts are capped at $2,650 for individuals and $5,250 for families. These limits increase every year based on inflation. Individuals over the age of 50 can make a catch-up contribution of $600 in 2005 (increasing by $100 per year to a maximum of $1,000 in 2009). Contributions can be made by you, your employer, or a combination of both. There are no income limits or requirements for setting up an HSA.

Individual contributions result in an above-the-line tax deduction on your income tax return. Any contributions made by your employer are not taxable to you. Self-employed individuals and employers can deduct contributions as well as insurance premiums. Individuals not covered by an employer’s medical plan can purchase a qualified medical insurance policy on their own and make tax-deductible contributions. However, premiums are not tax deductible for individuals.

Money in the HSA can be spent tax free on health care expenses, including eye care, dental expenses, prescription and non-prescription drugs, COBRA premiums, and qualified long-term-care services.

Unlike flexible spending accounts, you don’t have to use all the money in the current year. Any unused amounts stay in your account and grow tax deferred. Thus, individuals who can afford to pay their deductibles from personal funds can use the HSA as a way to save funds on a tax-deferred basis. This may be particularly attractive to individuals who have made the maximum contributions to 401(k) plans and Individual Retirement Accounts (IRAs), providing another way to save for retirement.

If you use funds before age 65, for other than qualified medical expenses, you must pay income taxes as well as a 10% penalty on the funds. After age 65, the 10% penalty is waived. At all times, the money in the account belongs to you.

After age 65, you can’t make new contributions to an HSA, but you can still use money in the account to pay medical expenses, including premiums for Medicare Part A and B and the employee’s share of medical insurance premiums paid by an employer.

Despite the benefits, not many employers currently offer HSAs, but that is expected to change in the near future. In a recent survey, 73% of companies indicated that they would add HSAs to their benefits by 2006 (Source: CNNMoney, October 22, 2004).


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