The majority of JRC clients have relatively simple life insurance needs–protection until the mortgage is paid off or the kids get through college age. Since their request for coverage is fairly basic, it is easy to determine a policy’s death benefit and term length.
But when there’s a special needs child in the home, responsibility extends much further, sometimes even into a second generation. Finding the correct amount of coverage without under or over insuring is often a bit more complex, which requires a more unique life insurance structuring. This article will review practical solutions to this situation while providing information on financial protection now and financial assistance in the future for the guardian and/or caregiver for the individual with special needs.
We’ll also discuss strategies that will allow you to preserve your child’s government benefits, while supplementing their income to provide a better standard of living with a special needs trust.
Life Insurance for a Special Needs Trust
The best solution for providing financial support and preserving government benefits for someone with special needs is by creating a special needs trust. The most popular and recommended way to fund your trust is with an affordable, permanent life insurance policy.
This will insure that money is left behind for your child no matter when you pass way. Most parents of special needs children establish a special needs trust to provide tax advantaged funds for their children after they pass. These funds can be used for care and shelter while preserving Medicare and Social Security Disability Insurance benefits. Many use a life insurance policy as the vehicle to fund the trust.
Types of Life Insurance Used for Special Needs Trusts
When looking to fund a special needs trust, some types of life insurance policies are more suitable than others. Along with not overpaying, most of our special needs parents tell us they want their life insurance to have three distinct features:
- A policy they won’t outlive
- Prices that won’t increase as they age
- A policy that can be cancelled without penalty if their special needs child precedes them in death
These requirements will generally eliminate term and most types of whole life insurance, which also includes non-guaranteed universal and variable policies. This is because whole and universal life insurance policies often offer cash accrual as well as investment and borrowing features which inflate the cost of your life insurance. In addition, you are required to pay extra money into the policy each month to build a cash value.
If you pass away before deducting the cash value of your life insurance policy, the life insurance company gets to keep the accrued cash value. If you deduct the cash value from your policy, it is considered a loan, and the death benefit of your policy is reduced until this loan is paid back with interest. In other words, your “cash value” is never really your money.
If you are unable to pay back the loan that you have taken out from your policy, you may lose your coverage. Additionally, non-guaranteed universal life insurance policies offer a guaranteed rate of return and a prospective rate of return.
The prospective rate in your policy is based on lofty investment returns that are rarely achieved and as you age, the cost of your insurance will increase. If for any reason your investment hasn’t performed extremely well, your life insurance will be underfunded. In order to avoid this debacle, you will want to lock in an affordable policy with guaranteed rates that do not rely on a prospective investment.
Guaranteed Universal Life Policies
When creating a special needs trust, guaranteed universal life policies are ideal. Guaranteed universal life insurance policies are competitively priced like term insurance and the rates and coverage are guaranteed until the age you choose. These policies offer guaranteed rates and coverage to specific ages like 90, 95, 100, 105, 110, or 121.
This coverage functions like term insurance without a cash value, but instead of locking in your rates for a specific number of years, you lock in your rates until a specific age. In reality, term life insurance options rarely extend past the age of 80, and most Americans live past this age. If you are purchasing life insurance to fund a trust to support a dependent child when you are no longer around, you will need to purchase a policy that will still be active when you pass away. A guaranteed universal life insurance policy, or “GUL,” is usually the most cost effective choice.
There is also an option to “annuitize” the death benefit which is generally desirable for a special needs trust. After you’re gone, you generally want to be providing monthly living and health care expenses to the trustee, rather than giving them a large lump sum (which is common with most life insurance). This can help preserve benefits eligibility and assure funds are used for purposes you’ve outlined in your trust. The annuitized death benefit choice is known to significantly reduce the cost of your insurance premiums between ten and thirty percent.
“Survivorship” or Second to Die Policies
Survivorship, or second to die policies, are also commonly used as vehicles to fund special needs trusts. A survivorship policy spreads the risk and the cost of the life insurance across two people, usually a husband and wife or child and parent. Both individuals are covered by the same policy, but joint policies pay after the second insured person dies. In other words, the death benefit on this form of life insurance is not paid until both individuals have passed away. Benefits of purchasing survivorship life insurance instead of two individual policies include:
- Lower cost of coverage than insuring two individuals with two policies
- Liberal underwriting (the “risk” is spread across two people)
- Deferred payout until the second person passes away (ideal for estate taxes)
Separate Your Life Insurance Coverage with Multiple Policies
In addition to the policy specifically designated to fund a special needs trust, it is common for parents to take out life insurance policies on each other. Since this means there will be multiple policies taken out, below shows a common structure that you can follow: POLICY 1: To provide long term care for special needs child, often through a special needs trust.
- Death Benefit: To figure out the amount of coverage needed, multiply the estimated cost of annual care by the number of potential years needed for care
- Term Length: Coverage is needed until the age of 80 or older
- Type of Policy: Term life or guaranteed universal life
- Beneficiary: A trust is often named as the primary beneficiary, though it is also common for a parent to name another child (who would provide care after their parents’ death) as a contingent or backup beneficiary
POLICY 2: To replace the family breadwinner’s future income.
- Death Benefit: To figure out the amount of coverage needed, multiply gross annual income by number of years until retirement
- Term Length: Term length is number of years until planned retirement
- Type of Policy: Term insurance is most appropriate
- Beneficiary: Typically the spouse
POLICY 3: To protect against the loss of the family caregiver, or stay at home family member, that provides care for your special needs child until you retire.
- Death Benefit: To figure out the amount of coverage needed, estimate the cost to replace the family care provided to your special needs child by the amount of years until your planned retirement age or earlier. (Most insurers would allow a sum to replace the breadwinner’s future income allowing them the choice to retire early, staying home to care for the child in place of the lost family caregiver).
- Term Length: Until the breadwinner retires or earlier. (Most insurers would allow a sum to replace the breadwinner’s future income allowing them the choice to retire early, staying home to care for the child in place of the lost family caregiver).
- Type of Policy: Term insurance is most appropriate
- Beneficiary: The breadwinner or family caregiver’s spouse
From here you can break the parent’s term insurance down even further. For example, when reviewing the information used in “POLICY 2,” the years of replacement income declines over time when life insurance is purchased to protect the family breadwinner’s future income. If you earn $50,000 annually and plan to work for 20 more years, you would multiply $50,000 by 20 years and learn that a $1,000,000 policy is appropriate for your situation. This means if you died tomorrow, your family would have enough money to replace your future income.
Although this policy seems ideal for your current situation, if you were to re-evaluate your coverage ten years from now, you would discover that $50,000 times 10 years would decrease your need for coverage amount to $500,000. After reviewing your options, you decide to purchase one 20 year term policy for $500,000 and one ten year term policy for $500,000 rather than purchasing one policy for $1,000,000 for 20 years. This strategy is called staggering, or layering, and it reduces your insurance premium cost.
The savings can be considerable which in turn can help you pay for the other policies, (most notably, POLICY 1, which directly supports your special needs child). Benefits of having a multiple policy strategy include lower cost for life insurance, easy designation of multiple beneficiaries, and maximum flexibility if finances change or the special needs child predeceases their parent. Raising a special needs child is emotionally and financially taxing. JRC takes pride in helping special needs families secure affordable, high quality life insurance with no games or gimmicks which could hurt you later.
We use our unrivaled ability to match our clients with life insurance solutions that will provide them with the best value in the industry. Our 40+ providers are all “A rated” for financial strength, security, and history of paying claims. You’re here today because you’re seeking peace of mind. Our life insurance partners have long histories of delivering on their promise of helping to provide financial security to parents. Give us a call today, toll free: (855) 247-9555
JRC does not provide legal or tax advice. Consult a trust attorney and tax professional experienced in working with special needs families.
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