Can I get a life insurance policy on my parents?

People buy life insurance policies for various reasons. Perhaps the most common, and the one that most people think about when they think about life insurance, is that young parents often take out life insurance policies to protect their children.

If you were to die prematurely and leave young children behind, the proceeds from a life insurance policy would replace the income you would have earned had you lived.

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Buying Life Insurance on Your Parents

There are many other reasons to buy life insurance and many other scenarios. For example, you may want to purchase a life insurance policy on your parents so that you, and your siblings if you have them, could purchase your parents’ house after they die.

A generation ago, most aging couples had paid off their home before they retired, and simply left the house in their will to their children. Today, many people are taking mortgages out later in life, or taking a reverse mortgage to pay for their retirement.

In either of these situations, there is an outstanding debt on the house when the owners die.

If the heirs cannot afford to pay the debt, they will be forced to sell the house rather than keep it in the family.

One way to be able to afford to keep the house is to purchase a life insurance policy on your parents, naming you and your siblings as beneficiaries. The face value of the policy should be enough to pay off the mortgage on your parents’ home when they die.

Another reason for wanting to have a life insurance policy on your parents is to pay the estate tax that may come due when your parents die. If your parents’ estate is large enough, the heirs may have to pay estate tax on their inheritance.

Some people purchase a life insurance with a face value that is roughly equal to the amount of the estate tax they expect their heirs to have to pay.

When the parents die, the heirs, who are also the beneficiaries of the life insurance policy, will receive the proceeds of the life insurance policy plus the assets from the estate less the taxes.

This should add up to roughly the amount of the estate if the math was done right.

For example, if Joe and Janet Smith have an estate valued at $7 million, it will likely be subject to estate tax.

Using the 2016 figures, the amount of the estate above the $4.45 million exemption allowed that would be taxed would be $2.55 million. At the 40% statutory rate, the estate tax due would be just a bit more than $1 million.

If the Smiths’ heirs had a life insurance policy on the Smiths with a death benefit of $1 million, they would effectively inherit the entire $7 million estate.

Note that the policy must be owned by someone other than the Smiths in this case. If the owner of a life insurance policy is also the insured, the death benefit gets added to their taxable estate.

If the owner is someone else, the death benefit goes directly to them and is not added to the estate of the insured. In other words, the death benefit is an asset of the owner of the policy.

If your parents own the policy, you would then need to recalculate the amount of the death benefit of the policy to account for the additional estate taxes that would result from the larger estate.

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Insurable Interest

There are four parties involved in a life insurance contract. They are the insurance company; the owner, who owns the policy and pays the premiums; the insured, upon whose death the death benefit will be paid out; and the beneficiary, who receives the death benefit when the insured dies.

The owner can also be the insured or the beneficiary.

The beneficiary is assumed to have an insurable interest in the life of the insured. This means that it is assumed that the death of the insured will have a negative impact on the beneficiary in a financial way.

Obviously, when a parent dies while they are still providing support for their child, the child would be impacted. Therefore, the child has an insurable interest in the parent.

Likewise, if a spouse who contributes to the family income dies, the other spouse would be negatively impacted financially.

Spouses have an insurable interest in each other.

If an insurance policy is purchased that names someone other than a spouse or child as the beneficiary, the beneficiary may need to prove they have an insurable interest in the insured.

For example, a creditor could have an insurable interest in someone who owes them money but only up to the amount of money owed. Employers or business partners may have an insurable interest in employees or partners whose death could cause a financial hardship to the business.

This is sometimes called key person insurance.

Buying Life Insurance on Non-Family Members

Most life insurance policies that are purchased for someone other than a spouse or a child fall into one of two categories: creditors or businesses.

If you owe money to someone, they can purchase a life insurance policy on you for the amount of the debt. That way, if you die before the debt is paid off, the proceeds from the life insurance policy will settle the debt.

In a similar vein, funeral homes will sometimes purchase a life insurance policy on people who want to prepay their funeral expenses.

The amount they pay is used to purchase a life insurance policy naming the funeral home as the beneficiary. When the person dies, the policy pays the death benefit to the funeral home, and the funeral home uses the money to fund the funeral.

Businesses sometimes purchase life insurance policies on key employees or partners.

A key employee policy may be purchased on someone who has very specialized knowledge that the business needs when it would be difficult or time-consuming to replace that person should they die.

The death benefit of this type of policy would pay the costs to keep the business running during the time it would take to find another person to take the position of the person who died.

If a business is a partnership, the partners may take out life insurance policies on one another.

This allows the remaining partners to buy out the estate of the partner who dies since shares of the partnership are an asset of each partner and would pass to the partner’s heirs.

Here’s an example. Moe, Larry, and Curly are partners in Stooges Enterprises. As the business takes off and becomes valuable, they realize they need to protect themselves in the event that one of them dies prematurely.

Three life insurance policies are purchased. One policy is purchased on the life of each partner, with the other two partners named as owners and beneficiaries. The amount of each policy is one-third of the value of the business.

A year later, Curly dies. The life insurance policy on Curly pays the death benefit to Moe and Larry. They can then use the money to pay Curly’s wife for the fair value of his third of the partnership.

Now Moe and Larry each own half of the business and Curly’s wife has been compensated for the value of his share.

It’s important to note that if the partners had not had life insurance, and Moe and Larry were unable to buy Curly’s share, the business would still have three partners: Moe, Larry, and Curly’s wife.

If Curly’s wife had no knowledge of how to help run the business, this would have been a problem. Since they had insurance, the business could continue and Curly’s wife receive her rightful inheritance.

If Your Parents Already Have Life Insurance

If your parents have an existing life insurance policy, it may be beneficial to transfer the ownership of the policy to you and your siblings.

This is especially true if your parents are considering surrendering the policy or letting it lapse, as some people do when their children become adults. They feel that they no longer need the protection of life insurance policy that they needed when their children were little.

If your parents have a term life policy, contact the insurance company to determine if the policy can be converted to permanent insurance. Term insurance, as the name suggests, only provides coverage for a specified term or length of time.

Term insurance policies are popular among young parents, as they provide a lot of coverage at a very reasonable price while the insured is young. As you age, however, if the term expires and the policy needs to be re-written, a term policy can get very expensive.

A permanent life insurance policy, which may be a universal life policy or a whole life policy, is meant to provide coverage for the entire lifespan of the insured. The cost is higher than a term policy, but the premiums and the death benefit will be the same for the life of the insured.

Many term policies can be converted to permanent insurance without additional medical underwriting.

This means that you may be able to take a term policy that was issued when your parents were young and healthy, and convert it to a policy that will cover them for the rest of their lives.

There may be no check of their medical records, so even people who have a medical condition that would preclude them from getting a new insurance policy may be able to convert an existing policy.

If your parents own a permanent life insurance policy but are considering surrendering it, or cashing it in, because they no longer want to pay the premiums, you may be able to take over ownership of the policy and pay the premiums yourself.

This would prevent you from having to take out a new policy on your parents, which would likely be more costly than an older policy, particularly if their health has declined.

It’s worth comparing the cost of a new policy with an existing one before you decide on a strategy. With people living longer and medical care improving, the cost of life insurance has declined in recent years.

If your parents are relatively young and do not have serious medical issues, a new policy may actually be less expensive than retaining one they already have. Compare the costs of both options and decide which one works best for you.

You Cannot Insure Someone Without Their Knowledge

It’s important to note that, while you can purchase life insurance on another person, the insured must be aware that you are doing so. The practical reason behind this is that the insurance company will want information on the insured, including their medical records, family history and so forth.

In addition, the insured has to sign the insurance application and consent to inquiries which may include medical information, a credit check, and a driving record check.

Life insurance can play a far bigger role in your overall financial plan than you might think. If you’re considering an insurance policy on your parents, it makes sense to fully explore all of your options before you make a decision.

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