title: Life Insurance Calculations & FAQs description: [AFW L.2] Frequently Asked Questions, Calculations and Options Regarding Term Life Insurance published: true date: 2026-06-30T08:10:01.351Z tags: editor: markdown dateCreated: 2021-08-12T04:19:17.149Z

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Two Variables of Term Life Insurance¶

The two variables in designing a proper life insurance program are:

the length of term, and
the amount of insurance.

The goal is to get the proper amount/length of both, but if the premium is too high then find a reasonable balance between the two.

1) Calculating the Proper Face Amount¶

Use the Life Insurance Amount calculator in the AFMS.
Rule-of-thumb: 10 to 15 times annual income.
Initial Liabilities + Monthly Income until Retirement.
Debts (burial, education expenses for children, mortgage, cars, credit cards, loans etc.)
Income replacement (sinking-fund).

2) Determining the Proper Term Length¶

Use the Two Phases of Income to help determine the proper length of term. Basically, it is based upon the minimum time needed to eliminate the risks you are covering (mortgage, college expenses, debt, income-replacement etc.). As a rule-of-thumb I usually recommend getting term length that covers the client to retirement age (usually 65).

Choosing a Beneficiary¶

The blank on the life insurance application form simply reads “Beneficiary: ______________.” Not a lot of room for what may be the single most important decision regarding your estate plan. Who should receive the insurance policy proceeds? The automatic response is: “My spouse, if living, otherwise, my then-living children.” But this arrangement is often inadvisable for several reasons, and the alternatives demand consideration.

Spouse¶

You may not want your spouse to receive substantial life insurance proceeds outright for several reasons:

The proceeds become subject to the claims of your spouse’s current and future creditors.
The proceeds may become subject to rights and claims of your spouse’s next spouse, or the next spouse may use influence to deprive your spouse, or eventually your children, of the proceeds.
If the proceeds are paid directly to your spouse, they cannot fund a credit shelter trust to take advantage of the current applicable exclusion amount. An over-funded marital deduction often ultimately results in higher estate tax.
Children and other relatives may ask your spouse for gifts or loans or may offer bad investment advice.

Children¶

Naming your children or surviving children as beneficiaries is a lottery approach.

You could be excluding a grandchild through a deceased child.
Many of the problems noted above for a spouse who receives substantial insurance proceeds outright also apply to outright payment of proceeds to children and grandchildren.
Whether your children have the maturity to handle money may also be an issue.

Estate¶

Designating your estate as beneficiary will have the benefit of bringing all your assets together for effective credit shelter tax planning and for the use of spendthrift trusts. But here are a few reasons why your estate should not be named:

The proceeds will become part of your probate estate and may be subject to creditors’ claims (though some state laws protect the proceeds from creditors).
The proceeds will increase the size of the probate estate and may result in higher executor fees and attorney fees — especially when the fees are based in part on the size of the probate estate.
The proceeds may not qualify for the inheritance tax exemption provided by some states for insurance payable to a named beneficiary. In such states, a higher tax may be owed.
The proceeds may increase your federal and state taxes and perhaps state death tax as well.

Testamentary Trust¶

Naming a testamentary trust as beneficiary of an insurance policy may be appropriate, but the law in some states is not clear as to whether this approach will exclude the proceeds from your estate. Where permitted, it will facilitate use of credit shelter trust planning and spendthrift trusts. Of course, your will should specifically designate the trust or trusts to which the proceeds should be allocated, but this predestination will reduce funding flexibility.

Revocable Trust¶

Where the insurance proceeds are substantial (and you have determined not to try to remove the insurance from your estate for estate tax purposes), you may name a revocable inter vivos (lifetime) trust as the beneficiary under the policy. The trust must exist before the designation is made and specify that the insurance proceeds cannot be used for certain estate obligations, such as creditor claims. Coordinate the trust with a pour-over will. This permits use of credit shelter trust planning and spendthrift trusts for your spouse and children.

Buy-Sell Agreements¶

Buy-Sell agreements and their funding are critical to a smooth transition of business ownership from one party to another. As a business owner, a buy-sell agreement provides a ready market for what is typically an asset without a public market. Without a buy-sell agreement, a deceased business owner's estate may be stuck with an illiquid business interest that may not be easily sold. A buy-sell agreement, properly funded with life insurance, is an ideal alternative to insure the business owner's illiquid business interest is converted to cash for the family.

The most common business continuity tool is a funded buy-sell agreement, sometimes referred to as a business will. The buy-sell agreement is inexpensive to draft and less complicated than other ways of transferring ownership and management of a closely held corporation. It can be responsive to changing circumstances, since alteration is possible with the consent of all parties.

The agreement is a legal contract restricting the right to dispose of a business interest to specified parties according to specified terms. It typically requires the sale of a business interest at a predetermined price or by a predetermined formula, triggered by death, disability, retirement, withdrawal from the business, or involuntary transfer of one of the owners.

For the family of a retired, disabled, or deceased shareholder, the agreement provides an orderly transfer of ownership and continuity of management, freeing it from business worries and assuring a fair price. If it is funded with life insurance, the agreement generates liquidity for the payment of the debts, expenses and taxes of the estate. The family will not be dependent on the business and its remaining owners.

With the agreement, remaining owners are assured that the stock will not fall into the hands of anyone not connected to the company or without an appropriate interest in running it. It may comfort the potential fears on the part of creditors or bonding companies. The agreement may also provide a method for withdrawing funds from a family corporation other than as dividends.

In short, the buy-sell agreement controls the disposition of all stock in the corporation in the event of a spectrum of contingencies. An effective buy-sell agreement should protect all parties from disadvantage by including all essential provisions key to the success of the arrangement. These provisions include, but are not limited to the following:

A statement of purpose of the agreement, outlining the intentions of the parties and objectives for the smooth transfer of the business interest. The promise to purchase/sell, identifying the purchasers and sellers of the interest and the percentages or shares to be purchased, as applicable. A valuation provision that establishes an agreed-upon price with provisions for re-evaluation at predetermined times, a formula for valuing the business at the triggering event, or procedures for selecting and using outside appraisers.

For life insurance funded agreements, instructions for the purchase of the life insurance and requirements for keeping the policy in force.

The terms of the buy-sell should specify how the purchasing party will pay for the business interest. Broadly, options include cash payments from savings, borrowing, installment sale, disability insurance proceeds, or life insurance proceeds.

Planned saving can be impractical since triggering events are likely to occur with little or no notice, and complete funding cannot be assured. Borrowing can be equally impractical since much of the lender's security depends on the stability of the company, which may be threatened by the shareholder's withdrawal.

Installment sales by themselves can place a burden on both parties to the transfer. The payments will drain current earnings as well as forcing the departing owner or heirs to rely upon the future success of the business, over which they no longer have management control.

Installment sales are often included among the provisions of buy-sell agreements to provide for payment beyond insurance funding solutions. This may be done as a two-pronged payment plan or as a fail-safe mechanism, should insurance be allowed to lapse or if increases in the value of the business overtake the amount of the insurance policy proceeds. Typically, in an installment plan the estate of the deceased takes a note from the corporation or remaining co-owners.

The heirs may actually feel very comfortable with this arrangement, since it provides an income stream for them. But, as an unfunded obligation of a corporation or its owners personally, installment payment plans must be carefully analyzed and periodically reviewed.

The potential mistake of this kind of clause in the buy-sell agreement is no different in concept from the common mistake of credit card debt. The business cannot simply expect that future revenues will be able to support the installment agreement. In some cases particularly in businesses with narrow profit margins the increased sales needed to generate cash for the payments can far exceed any reasonable revenue expectation or historical model. Even more sobering is the fact that, since the installment payment is not deductible, revenue calculations must reflect after-tax dollars.

Given these potential problems, the combination of disability and life insurance typically proves to be the least costly of these options. The most significant advantage is that complete financing is guaranteed from the beginning. A lump sum payment to the deceased stockholder's estate is generally feasible only if life insurance proceeds are available to fund the payment.

Furthermore, life insurance proceeds are received by the beneficiaries free from income tax, except for the corporate AMT. Cash values in the policy can also be utilized for a buyout of a retiring or disabled partner and allow the withdrawing partner to keep the policy. However, the trade-off for the tax free proceeds is that the insurance policy premiums are not tax deductible.

Life insurance funding avoids bank and bonding company problems. The credit position of the firm is not affected by a deceased shareholder's stock in the firm, and the selling shareholder does not need to depend on the credit-worthiness of the company for an extended period.

On the disadvantage side, insurability may be a problem or, due to age differences among shareholders, premiums may not be equitable. This can usually be addressed with appropriate compensation measures.

Key Person Life Insurance¶

Protect Against The Unexpected¶

The untimely death of a key person such as an owner, partner or majority shareholder often has a significant impact on a closely held business. Replacing the expertise and knowledge of an essential individual can take time and money and may even jeopardize the continuity of the business. You'll also need to assure creditors and customers that everything is fine. A key person life insurance policy can help the transition. Help heirs meet estate tax obligations without compromising or dissolving a family business Keep the business running and assure creditors and customers that the company will operate as usual Reduce the impact of the untimely death of a key individual by covering expenses of finding and training a suitable replacement

Protect the value of essential employees¶

Don't let the unexpected devastate your business. Key Person Insurance can protect your company's solvency in the event of losing an essential employee or founder. It pays the company a benefit that can be used to keep the company running

This assures creditors that they will be paid on time while comforting customers that your business will continue to operate as usual. It can also be used to cover expenses related to finding and training a replacement.

How Key Person Insurance works¶

With Key Person Insurance, the business buys a life insurance policy on the life of the key executive, and is the owner and the beneficiary of the policy. The business pays the entire premium and will receive the entire death benefit. The executive does not have any interest in the policy, nor does his family receive any benefit from it when death occurs.

As a business owner you cannot do it all. You rely on a few key employees who help make day-to-day operational decisions, who play a key role in obtaining credit with a financial institution or who oversee all sales activities. Losing one of these key employees could set you back.

Key person life insurance provides life insurance protection on the life of a key employee and is purchased to help reimburse the business owner from economic loss caused by the death of the employee.

The insurance may be purchased and used for key person insurance to help bridge the gap of the lost revenue or increased expenses due to a loss of a key person. This would allow the business to continue to operate and provide the funds necessary to recruit a new employee to take over the key person's functions.

By using life insurance, the death benefit would be available to pay for an employee search, pay that person's salary and create a cash cushion for the business during this trying time.

The life insurance can also guarantee a specific death benefit precisely when the money is most needed, provide tax deferred accumulation of cash value and minimize the impact on the business's financial statements.

Generally speaking, insurance premiums are nontaxable to the insured if the policy is purchased for the benefit of the business and the insured has no interest in the policy. However, if any proceeds from the policy are paid to the employee or his or her beneficiary, they could become taxable income.

Buy-Sell agreements and their funding are critical to a smooth transition of business ownership from one party to another. As a business owner, a buy-sell agreement provides a ready market for what is typically an asset without a public market. Without a buy-sell agreement, a deceased business owner's estate may be stuck with an illiquid business interest that may not be easily sold. A buy-sell agreement, properly funded with life insurance, is an ideal alternative to insure the business owner's illiquid business interest is converted to cash for the family.

Taxes on life insurance: Here’s when proceeds are taxable¶

Read Taxes on life insurance: Here’s when proceeds are taxable ARTICLE

If the estate is worth more than $11.4 million.

Only spouses are exempt from getting taxed in life insurance policies. Anyone else, like a parent or sibling, will have to pull the proceeds from an estate. This means the money is subject to taxation, if the estate is large enough.

In 2019, the Federal Estate Tax Exclusion amount is $11.4 million for individuals. If someone were to pass away and have an estate valued above that amount, any amount above the threshold would be taxed at 40 percent.

“This can happen when a beneficiary is not chosen, or the beneficiary passes away before the policyholder,” says Phil Murphy, vice president of insurance at Ethos. “This can be avoided by naming a contingent beneficiary in addition to your primary one.”