How can you be guaranteed to make a small fortune? Answer: Start with a large fortune and then invest poorly. Fortunately, life insurance does the opposite. You can take a relatively small amount of money and convert it into a larger pool of money–guaranteed. The caveat is that you have to die first. Eventually, however, we all wake up to find ourselves playing the long version of “Stairway to Heaven.” That being the case, why not make use of this valuable tool to secure your disabled child’s financial future?
The death benefit of the life insurance policy should nearly always be placed in a special needs trust. For purposes of this article, however, I want to focus on the reasons, or benefits, of using life insurance for providing financial security for your child. It may be appropriate to begin by addressing some of the more common reasons people give for not purchasing life insurance.
Objection: My child won’t need very much money since the state will take care of her.
Answer: At best, the state will take care of your child’s basic needs. The lack of funding, however, is placing even that assumption into question. Consider that there are currently over 100 disabled individuals on the Priority 1 List. This list is for those individuals who urgently need a group home placement due to death or disability of the parent or caregiver, and other dire issues. The fact that even under these circumstances there is no placement available should concern us regarding current and future services.
Do you want your child to have the extras that make life more meaningful—money for hobbies and interests, vacations, electronics, computers, TV, etc.?
How about medical? The state is transitioning to a managed care system. Most disabled individuals require more medical care, not less. If your child is fortunate enough not to require medical care now, what about increased medical needs as he ages? If you want access to providers outside the network, you will need to pay for it—either with cash or through a private health insurance policy.
Will your child need extra care? Will you need to pay for someone to advocate for her when you are no longer around? This all costs money. Where is it going to come from?
Objection: One of my other children will care for my child.
Answer: Perhaps, but did everything go as you expected during your lifetime? No. It doesn’t for any of us. So why would we expect that it will for our children. Financial reversals, divorce, bankruptcy, unexpected illness, disability or death. Isn’t it our responsibility to provide financial security for our disabled child?
Objection: I’m better off purchasing term insurance and investing the difference in premium costs in an investment portfolio.
Answer: The assumption here is that you’re going to live to a normal life expectancy. That being the assumption, why even purchase term insurance? While we hope and expect to live a long life, we purchase insurance to protect our families in the event that doesn’t happen. If we do die prematurely without insurance, our investment plans go out the window. This is why in any financial model, legal documents and insurance create the foundation on which the investment portfolio is built.
In reality, few people actually adhere to the plan of investing what they are “saving” in insurance premiums. And even if they do, it would take decades to replicate what an insurance policy would provide. And there isn’t any guarantee that it will, as we have recently experienced with the great recession.
There is an additional obstacle. We usually fund our retirement accounts first because of tax incentives and matching contributions. Retirement accounts, as we will see shortly, are not the optimal source for funding a special needs trust.
Objection: My estate is large enough so that I don’t need life insurance to provide financial security for my disabled child.
Answer: Even people with sufficient assets are often concerned with financial reversals and the possibility of needing long-term care and the effect that would have on their ability to fund their child’s future.
Objection: I can’t afford the premiums for permanent life insurance.
Answer: One answer may be to purchase an appropriate convertible term insurance policy with less expensive premiums now, and convert it to permanent insurance at a later date when you have more discretionary income. You won’t have to pass medical tests when you convert, avoiding the potential issue of insurability at a later date.
Another potential solution is Supplemental Security Income (SSI). If your child begins to receive SSI payments, you will most likely want to claim reimbursable expenses in order to maximize your child’s benefits. You can then use a portion of the reimbursable expenses to pay premium payments on life insurance with yourself, your spouse, or both as the insured. Your child’s trust would be the beneficiary.
Now that we’ve addressed the more common reasons for not purchasing life insurance, let’s look at why it can be so useful.
Leverage: Life insurance can be a great way of converting a relatively small stream of money into a large pool of money, or a pool of money into a much larger pool.
The first concept is pretty easy to understand. A monthly or annual premium guarantees a certain amount of death benefit when you die, no matter when that occurs. There are different kinds of policies with different rules, some of which are more flexible than others, which I’ll discuss in another blog.
Converting a smaller pool of money into a larger pool of money is a great way to increase the assets going into a special needs trust. Let me give you an example of how this might work. Let’s say a grandmother has the financial means and desire to gift $100,000 to her special needs grandson. In her desire to maximize the size of the gift, she takes out a life insurance policy on one or both of the parents, with their approval. The death benefit on such a policy (or combined policies), depending on the age and health of the parents might easily be $700,000. When the parents die, the money will go into a special needs trust for the child, providing the financial security the child needs, when he most needs it.
Income Tax: If you were to use your retirement assets to fund a special needs trust, any tax-deferred assets over $12,000 (approximate) would be subject to the current maximum federal tax rate of 39.6%.
Life insurance, on the other hand, is not subject to ordinary income tax. If you had an insurance policy with a $1 million death benefit with the trust named as the beneficiary, the entire $1 million would go into the trust, available for investment in a suitable portfolio.
Estate Planning: Insurance can be used to balance your estate for inheritance purposes. Your special needs child may need more than an equal share of your estate. We have already discussed why we would prefer not to use retirement assets to fund an SNT. The home is usually one of the largest assets in one’s estate, but it may take time to liquidate and the market value fluctuates. The benefits of a life insurance policy can be used to fund your child’s future, while allowing you to divide the remainder of your estate as you wish and avoid the severe tax implications of placing tax-deferred assets into the trust. If done correctly, it will also help avoid future sibling disputes regarding your disabled child’s portion of the estate.
Individuals with disabilities are living longer, and with decreasing government benefits and resources, parents are experiencing the burden of finding a way to provide financial security for their child for the time when they are no longer around. Insurance, because of its unique features, offers a practical way for many parents to best achieve the goal of financing the future for their special needs child.
Need Life or Disability insurance? As an independent consultant, I am product-neutral with access to over 40 insurance companies. This allows me to offer you the most appropriate and cost-effective strategies and solutions to your unique situation. Other services include:
SSI/Medicaid Benefits Planning & Analysis