People often think that the insured person of a life insurance policy must also be the policyholder, but that’s not true. You can buy life insurance that provides a payout following the death of someone else.
Buying life insurance on someone else requires careful consideration of the legal, ethical and financial implications. While there are plenty of pros, there are also potential drawbacks.
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How to Take Out Life Insurance on Someone Else
It’s simple to buy life insurance on a business partner or loved one, provided that you have an insurable interest and the insured person is aware this is being done.
Obtain Consent and Information
The next step is to obtain consent from the person being insured. This means making it clear that life insurance is being taken out in their name and obtaining written or verbal agreement that the person is aware.
During this process, you will also need to collect information necessary for the application process, such as contact details, age, and medical history. It is also important to make sure the person being insured understands any responsibilities related to the underwriting process.
In today’s marketplace, you may be able to buy life insurance with no medical exam, but the insured person might need a medical exam.
Determine the Insurable Need
Before purchasing life insurance on someone else, it is important to assess your insurable need, which is the amount of money you’ll need in the event of their death. Determining an appropriate life insurance coverage amount requires a thorough understanding of factors such as income, financial obligations and future expenses. The reason this is important is that insurable interest is based upon what you stand to lose financially if the insured person were to pass away unexpectedly.
Here are two more simple ways to see and calculate your insurable need:
- Mortgage replacement. If you are married and own a home together, chances are that you qualified financially for the home with your joint income. If one of you were to pass away, what kind of financial impact would that have on you and your family? If you have a mortgage with a remaining balance of $350,000 and a payment of $2,300, how much would it impact your budget if the home was paid off in the event of one of you passing away?
- Income replacement. Let’s say you and your spouse each make $5,000 per month. If your spouse passes away, how quickly would you spend through your savings while grieving, and how long could you continue your current lifestyle on just one income? Would you need childcare and could you afford it? One strategy is to buy enough life insurance to replace the deceased spouse’s income through their children’s education years. If this is 10 years from now, you’d need about $600,000 in coverage, not accounting for inflation (10 years ✕ $5,000 per month ✕ 12 months). This at least allows you to keep life as normal as possible during a difficult time for as long as you can.
Policy Ownership and Beneficiary Designations
The policy owner (sometimes referred to as the policyholder) has all legal rights concerning the policy, including the right to change or cancel the policy, make changes to the beneficiaries, transfer ownership and borrow against the cash value of the policy.
The insured person’s only role in the policy is to go through underwriting. The process often involves determining a contingent owner of the policy, which is the person who would take over the policy if the policyholder predeceases the insured person.
An irrevocable beneficiary assignment is sometimes used in situations where a person is buying life insurance on someone else. The word “irrevocable” means that the beneficiary cannot be changed. As the insured, you may feel more comfortable with a policy on your life when the beneficiary is fixed. Of course, policyholders need to use caution with this assignment because it cannot be changed. However, you may set up a contingent beneficiary, who will become the beneficiary if the irrevocable beneficiary dies first. The death benefit will pay out only to living beneficiaries.
Since personal finances can change quickly, it’s important for policyholders to check in regularly with their financial advisors and spouse or business partner to assess what changes are necessary.
Premium Payments and Policy Maintenance
So… who’s paying for the policy? Most often, the policyholder is also the payor. The payor and payment methods can generally be changed by the policyholder at any time. To avoid a lapse in coverage, it is typically advised to set up automatic payments and make sure accounts are being funded properly to handle the payments. If you lapse a policy that was purchased on someone else, you may have to go through the entire setup process again with the insured person.
Reasons to Buy Life Insurance for Someone Else
People purchase life insurance on other people for a variety of reasons. Still, in every case, it’s about protecting themselves from financial hardship in the event that something happens to the insured individual. Here are a few reasons why you might buy a life insurance policy on someone else:
- You’re financially reliant on another person. If you are receiving financial support from a parent or alimony from a former spouse, buying life insurance on them could provide comfort that your needs will be covered after their death.
- You’re looking out for your grandchildren. Some parents buy life insurance on the lives of their adult children for the benefit of their grandchildren. Their adult children may not have it in their budget to buy life insurance, leaving the grandparents with the option to buy a policy that makes sure their grandkids are protected.
- You’re a business owner. If you own a business, you may buy life insurance on a business partner. This may allow you to be able to buy their interest in the company without the need to take on debt.
There are plenty of situations where it makes sense to buy life insurance on another person. Before you start shopping for policies, you should study the legal and ethical implications.
Legal and Ethical Considerations
In general, you can only take out a life insurance policy on a person for whom you have proof of insurable interest. In other words, you must be at risk of a financial loss after the death of the insured person.
From an ethical standpoint, it’s essential to ensure that all parties involved understand the implications of such a purchase before making any decisions. Every insured person has a maximum amount of life insurance they can buy, and if you buy a policy on them, it may limit their ability to add more coverage for their personal planning. This may not be an issue, but it is important to make sure all parties are aware.
Who Can You Take Out Life Insurance On?
There are many different types of people you can buy life insurance on. Here are just a few of the most common types of people you can buy life insurance on and some helpful reasons why someone may consider this.
- Spouse: Buying life insurance on a spouse —or ex-spouse — can be a valuable part of a financial plan. If your spouse is the family’s breadwinner, you might buy life insurance for your spouse to cover final expenses, including funeral expenses and unsettled health expenses. You could also put the life insurance payout toward income replacement, paying off your mortgage or estate planning.
- Children: Many people buy life insurance on their minor child to protect their future insurability or to provide some money for them through the cash value account. Children are more likely to get stronger rates with no-exam life insurance because they’re young and healthy.
- Grandchildren: A common strategy is for grandparents to buy a life insurance policy on their grandchildren. This is a nice legacy gift that protects your grandchildren’s future insurability, provides some cash value later in life and reminds the grandkids of their legacy.
- Business partners: If your business partner were to pass away unexpectedly, how could your business handle buying out the partner’s family? This is why it’s common to have a buy-sell agreement with your business partner. Buy-sell agreements are most commonly funded with term insurance, the cheapest kind of life insurance.
- Key employees: Making sure your company can survive and thrive after the death of a key person is important. Having key person life insurance fund the replacement of revenue lost or new expenses is important to your livelihood. These policies are often whole life insurance because it lasts the life of the insured and allows the business, as the policyholder, to build cash value.
Types of Life Insurance Policies You Can Buy on Someone Else
You can buy any type of life insurance for yourself and when you are buying it for someone else. Here is a brief rundown of why someone may consider each type of life insurance product.
- Term life insurance: Term life insurance provides the most competitive life insurance rates and is the least expensive way to buy life insurance. It’s also useful when covering short-term needs, such as a credit card or loan that will take 10 years to finish paying or a child’s college education that you’ll need 15 years to save for.
- Whole life insurance: This type of cash-value life insurance is designed to have guaranteed growth and non-guaranteed dividend growth. This is often attractive because you can predict your cash value accumulation with more certainty compared to other products.
- Universal life insurance: This type of permanent life insurance grows at a fixed interest rate that is declared each year and is designed to have flexible premiums. It is often attractive when you want some cash accumulation and are interested in the ability to stop and start premiums due to variable income structures.
- Indexed universal life insurance: This type of permanent life insurance provides similar features to universal life insurance but varies in the way cash value accumulates. It may provide higher upside potential and reduce or remove the effects of negative market performance. Unlike whole life insurance and universal life insurance, it lacks the certainty of return. People often choose this product type when they want a greater upside potential compared to whole life and universal life, and they are comfortable with receiving no market returns if the market is negative.
- Variable universal life insurance: This type of permanent life insurance provides similar features to universal and indexed life insurance but varies in the way cash value accumulates. Variable universal life utilizes sub-accounts that invest money in the market similarly to the mutual funds they represent. If you are looking for a market-like performance and are willing to last through market downturns, variable universal life can be an attractive way to go.
Potential Challenges for Buying Life Insurance on Someone Else
It may be uncomfortable to ask someone if you may buy life insurance on them. Perhaps the most significant challenge is being able to articulate why you are interested in buying life insurance on them. Here are a few tips on how to work through this process:
- Start with a direct conversation to walk them through your reasoning. Have numbers to support your idea. Honesty is the best policy at this first stage.
- Consider talking through the issues you see in your planning, and start the conversation by asking them for some ideas on how to address those.
- Your financial advisor or life insurance agent likely has documentation supporting your insurable interest and the reasons why taking out a life insurance on a family member or business partner could be an effective strategy for you. Consider involving them in the life insurance needs planning and in the delivery of the insurance plan.
- Realize the worst the person can say is no. Sometimes these topics take multiple conversations to get actionable movement. Just bringing up the topic brings awareness and may allow future conversations to still take place.
It is not ethical, nor is it allowable, to buy life insurance on someone without their consent. It’s crucial to have these conversations and not only make the person aware of what is going on, but also gain their consent to continue.
Frequently Asked Questions About Buying Life Insurance for Someone Else
Yes. You will need to make sure you have an insurable interest in the person and consent from the person before applying for life insurance coverage.
No. Buying life insurance on someone without the person’s knowledge or consent creates both ethical and legal concerns.
Yes. While you may not buy life insurance for financial loss as the primary reason for the amount of coverage, you can protect the future insurability of your child by purchasing a policy.
No. The insured person will need to sign the application, and you need to make them aware of what the person is signing.
Methodology: Our System for Rating Life Insurance Companies
Our team researches and ranks life insurance companies using an in-depth scoring system that considers the factors most important to consumers like you. Our analysis includes a comprehensive review of each provider we feature based on available coverage, customizability, availability, customer service and company reputation. Here are the factors we take into consideration when rating life insurance providers:
- Brand trust (40%): Life insurance payouts can exceed $100,000 or more, which makes choosing a reputable and trustworthy insurance provider important. To assess brand trust, we use J.D. Power and Associates customer satisfaction surveys, AM Best credit rating scores and the National Association of Insurance Commissioners (NAIC) complaint index. The higher a company scores in each area, the more points it receives.
- Coverage (33%): The more policy options a life insurance company offers, the more opportunities you have to obtain the right coverage for your specific needs. For this reason, we give companies the most points for offering multiple types of life insurance, including various term, permanent and no-exam options.
- Availability and ease of use (19%): Since life insurance coverage options can be complex, we consider the ways a customer can reach a company — and how easy communication is. For this category, we research how many communication channels a company offers for general customer support, claims processing and the application process. Companies earn the most points for offering various ways to interact with an agent, both in-person and online.
- Riders (8%): Companies offering various life insurance riders or endorsem*nts allow policyholders to better customize their coverage. In this category, we determine how many riders a company offers and award the most points to providers with more than 10 options.
We use our rating system to compare and contrast each company against key factors to help us determine the best life insurance companies in the industry. To learn more, read ourfull life insurance methodologyfor reviewing and scoring providers.
AM Best Disclaimer
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