We explore the ins and outs of taking out a policy on your parents — even if they’re ill or elderly.
The unexpected death of a parent can be extremely overwhelming, and that’s before you even consider the financial implications. If you’re unsure if your parents can cover their debts or medical expenses as they get older, you might consider getting life insurance for them.
Life insurance can help if you’re looking for a steady long-term investment or a way to protect your family if someone dies. Life insurance can provide both financial protection and a way to grow your estate, but it can be hard to pick the right policy. Here to help you navigate the technical language and never-ending assortment of policy options, this guide covers how to buy life insurance for your parents.
Can you actually buy life insurance for your parents?
You wonder if it’s actually possible to buy a life insurance policy for your parents, and the short answer is yes. Buying a life insurance policy for your parents is like buying a policy for yourself — with some key differences. You don’t even need to be a blood relative to buy life insurance for someone else. What you need is something called insurable interest.
What is insurable interest?
Insurable interest is proof that you stand to suffer some sort of financial loss when your parents die. This requirement prevents people from benefitting from policies they take out on people they expect to die soon. Whether you’ll be taking on your parents’ debt or paying for final expenses, family members generally shouldn’t have an issue proving insurable interest.
Once you’ve proven your insurable interest, you’ll need to determine an appropriate amount of coverage. Too much coverage could raise red flags with the insurance company, whereas too little could leave you unable to fulfill your new financial obligations. This is why it’s important to understand exactly how much insurable interest you would have if your parents were to pass away.
How to buy a life insurance policy for your parents
Buying a life insurance policy for your parents is just like shopping for coverage for yourself. However, to determine the right provider and policy for your situation, there are a few steps to consider:
- Consent. Before looking into life insurance policies for your parents, you should first make sure they agree. Without the OK from your parents, you can’t move forward with the policy. This prevents policies being taken out on people without their knowledge.
- Insurable interest. Once you have consent, you’ll need to establish insurable interest to prove that you stand to experience financial loss when they die.
- Amount. Determine how much coverage you’ll need depending on you and your parents’ financial situation. Consider consulting with a financial adviser.
- Type. There are three main types of life insurance: Term, whole and universal. To make sure you have the protection you need, discuss the type of policy best for your situation.
- Ownership and beneficiary. If you’re looking for life insurance for your parents, chances are you’ll also be the owner and beneficiary of the policy. However, this isn’t always the case. Determine who’s in charge of the policy and listed as a beneficiary.
- Payer. Most of the time, the owner of the policy is in charge of making payments, but your situation may be different. Speak with your parents and your provider to determine who’ll make payments on the policy.
Can I still buy a policy for my parents if they are not in good health?
If you’ve ever looked for a life insurance policy for yourself, you may have noticed that there are providers willing to insure applicants in poor health. While some may be more accepting of certain ailments over others, you should have no problem buying a life insurance policy for parents in poor health. You just may pay more.
Just like shopping for your own life insurance, compare your options before deciding on a policy. In this situation, consider looking for providers with more lenient underwriting guidelines or those that advertise coverage for pre-existing conditions.
Why consider taking out a life insurance policy for your parents?
There are a number of reasons to take out a life insurance policy for your parents. Even if you don’t rely on them for financial support, life insurance offers financial protection that you likely won’t find elsewhere.
- Funeral expenses. When all is said and done, funerals can cost $10,000 or more. Life insurance can help cover funeral expenses so that you’re not forced to pay out of pocket. Some policies even offer specific add-ons to cover these expenses — something to consider as you shop around.
- Health care. Whether your parents’ health is declining or they have routine medical costs, life insurance can help cover the bills. Depending on the coverage, your policy might offer an early or increased payout to cover medical expenses. Speak with your provider to determine which policy and riders are best for your situation.
- Debt. If your parents have any outstanding debt, be it mortgage payments, credit card bills or anything else, you may be held financially responsible when they die. Life insurance can provide the means to pay off any outstanding debts. Speak with your provider to determine how much coverage you’ll need to pay off debts, medical and final expenses.
- Replacement income. If you, your spouse or other dependents rely on your parents for income, life insurance might be a good idea. Even if you’re eligible for government assistance programs, a life insurance payout can supplement your income to help you remain financially stable after a parent dies.
- Taxes. If you’re responsible for the inheritance or estate tax when a parent dies, it’s likely you’ll pay taxes. How much taxes you’ll pay depends on factors like their state of residence and net worth.There are often thresholds to be met before any taxes apply, but it never hurts to be prepared. Life insurance can help reduce the financial burden of taxes.
- Legacy. Many people purchase life insurance for their parents if they plan to leave an inheritance or legacy to their next of kin. Whether it’s cash, property or retirement funds, life insurance payouts can provide a substantial amount of savings to beneficiaries.
- Charitable donations. If you or your parents would rather donate to a charity, consider doing so through life insurance. While cash donations go a long way, life insurance payouts can provide a much larger contribution since the proceeds are generally tax-free.
What type of life insurance policy should I take out for my parents?
Just like shopping for your own life insurance, there are a handful of options when it comes to choosing a policy for your parents. While you’ll need to consider things like term length, policy features, add-ons, coverage amounts, your main decision will be to choose from these three types of life insurance:
Term life insurance
This type of life insurance is best for those looking for affordable financial protection after the insured dies. Whether your parent has credit card debt, mortgage bills or any other outstanding debt, term life insurance provides a predetermined payout if they die while the policy is active.
Whole life insurance
Whole life insurance is the standard option when it comes to permanent coverage. It offers financial protection for life or until the maturity date, usually by their 100th or 121st birthday. Premiums are generally much higher than term life insurance, but they’re distributed into both the death benefit amount and a cash value. The cash value portion of the policy grows over time and often allows you to pay premiums or take out loans from the amount.
This type of life insurance is best bought earlier on in life to allow more time for cash value accumulation. However, these policies can be purchased at almost any age and can provide substantial coverage.
Universal life insurance
This type of life insurance is best for those who are looking for an investment-heavy financial protection. Whether the payout is donated to charity, passed to the next of kin or used to pay off taxes and debts, universal life insurance policies are the most comprehensive and expensive type of life insurance.
What is the Goodman Triangle and how you to avoid it.
Life insurance payouts to beneficiaries are generally not taxable. Estate taxes only apply if the value of the estate exceeds the threshold, which is $11.2 million for 2018. Beneficiaries are generally exempt from inheritance taxes, and will likely receive the entire death benefit amount. However, there is an exception called the Goodman Triangle that creates an unexpected gift tax liability.
Generally, life insurance policies involve three parties:
- Person A — the insured
- Person B — the policy owner
- Person C — the beneficiary
In many situations, the insured is also the owner of the policy, but when it comes to buying life insurance for your parents, that’s not the case.
The Goodman Triangle occurs when the owner of a life insurance policy is not the insured and not the only beneficiary. When the owner of a policy appoints a fourth party — another beneficiary, their payout is considered a gift.
While the owner of the policy is still alive, they have the power to remove beneficiaries, and any payout is considered incomplete. Once the insured dies, the gift is deemed completed. Unlike life insurance payouts, gifts are subject to taxes, and the owner of the policy is responsible for that tax payment.
Here’s an example:
Jerry has two children, Mike and Bob. Mike takes out a life insurance policy on Jerry for $1 million with the understanding that the payout is split between the two siblings.
Bob is named the beneficiary but isn’t listed as an owner of the policy.
When the death benefit is paid out, Mike and Bob both receive $500,000. But because Bob isn’t listed as an owner, his half is considered a gift from Mike — the owner of the policy. Mike is now responsible for the gift tax on $500,000.
How can you avoid the Goodman Triangle?
There are a few ways you can avoid running into the Goodman Triangle:
- List only one beneficiary, but that might prevent other beneficiaries from getting their share.
- List all beneficiaries as owners of the policy. But there are cases where the insured is against certain beneficiaries having power over the policy.
- Register an irrevocable life insurance trust as owner of the policy. While it isn’t free, it keeps the death benefit separate from the estate and avoids gift taxes.
Bottom line
Yes, you can buy life insurance for your parents. The process is not much different than buying a life insurance policy for yourself, but there are a few considerations. Consult a financial adviser and your provider before making any final decisions. Once you’re ready, compare your options with our comprehensive guide to life insurance to find a provider and policy that suits your needs.
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