As we make our way through September, it’s essential to highlight the significance of Life Insurance Awareness Month. This month serves as a reminder for individuals to evaluate their life insurance needs and ensure they are making informed decisions regarding their policies. Life insurance is a crucial financial product that can provide peace of mind and financial security for your loved ones. However, many people overlook critical aspects when purchasing or managing their policies, which can lead to costly mistakes.
Understanding life insurance mistakes
Many individuals fail to conduct the necessary groundwork before purchasing a life insurance policy. This oversight can result in severe repercussions down the line. Here are four common mistakes to avoid when dealing with life insurance:
Mistake #1: Not reviewing your policy regularly
One of the most significant mistakes you can make is neglecting to review your life insurance policy. It is advisable to conduct a policy review at least once a year or whenever you experience a major life event. Life-changing events can include: getting married, having a child, buying a new home, changing jobs, divorce, starting your own business and relocating.
A thorough review ensures that your coverage aligns with your current needs. Before making any changes, consider factors such as your health status, insurability and any associated fees with terminating an existing policy.
Mistake #2: Naming your estate as the beneficiary
Another common mistake is designating your estate as the beneficiary of your life insurance policy. Doing so can expose the policy proceeds to probate, creditor claims and potential estate taxes. This situation can easily be avoided by ensuring you have a designated beneficiary. If your primary beneficiary dies, it’s crucial to update your policy to reflect a new beneficiary to prevent your estate from becoming the default beneficiary.
Mistake #3: The “Triangle” of ownership
In life insurance, a “Triangle” occurs when three different parties are involved: the owner, the insured and the beneficiary. This arrangement can lead to unintended tax consequences. A federal court ruling from 1946 established that if the insured dies while this triangle exists, the policy owner may be deemed to have made a taxable gift of the entire death proceeds to the beneficiary. To avoid this, ensure that either the owner and insured are the same person or that the owner and beneficiary are identical.
Mistake #4: Taking premature withdrawals
Life insurance policies often accumulate cash value, which can be an excellent source of retirement income. However, withdrawing or borrowing from this cash value can decrease the policy’s death benefit. It’s essential to understand the implications of such withdrawals, especially under the cash-rich rules established by the Internal Revenue Code. These rules can result in tax liabilities if cash distributions reduce the death benefit within the first 15 years of the policy. To avoid these tax consequences, consider waiting until after year 15 to withdraw or structuring the distribution as a loan.
As we observe Life Insurance Awareness Month, take the time to educate yourself about the common pitfalls associated with life insurance. By avoiding these mistakes, you can ensure that your policy serves its intended purpose: providing financial security for your loved ones.
