Summary

• Spousal protection provides financial security and support to a surviving spouse upon the insured’s death.
• Life insurance can protect a surviving spouse by providing income replacement, debt repayment, childcare, education funding, estate equalization, business continuity, and covering final expenses.
• Advisors can utilize various life insurance policies and ownership structures depending on the client's needs.

Life insurance for spousal protection: How it works

Life insurance can provide financial security and support to a surviving spouse in the event of the policyholder's death. 

The death benefit from the life insurance policy can serve as a crucial source of income replacement, debt repayment, and overall financial stability for the surviving spouse, helping them navigate challenges that arise after losing their partner.

The importance of life insurance for spousal protection

Life insurance can play a crucial role in providing spousal protection in the event of the policyholder's death. Life insurance can offer many benefits to the surviving spouse, including:

1. ‍Income replacement: The death benefit can help replace lost income and ensure financial stability for the spouse and any dependents.‍
2. Debt and mortgage repayment: Life insurance can pay off outstanding debts, such as a mortgage, personal loans, or credit card balances, relieving the surviving spouse of those financial obligations.‍
3. Childcare and education: Life insurance can provide funds to ensure the surviving spouse has the financial means to provide for the children's needs and educational expenses.‍
4. Estate equalization: When one spouse has significantly more assets or wealth than the other, life insurance can balance the distribution of assets among the children or other beneficiaries. ‍
5. Final expenses: Life insurance can help cover funeral and burial expenses, which can be significant costs that the surviving spouse may have to bear.

How individuals can obtain the right coverage

There are three ways life insurance products can help provide protection in the event of one spouse's passing:

Individual policies

The most common way for spouses to obtain life insurance protection is to purchase individually-underwritten policies. It is common for both spouses to be insured, although not required. Several types of policies are available, including:

• Term life insurance: Term life insurance covers a specific period, such as 10, 20, or 30 years. It offers a death benefit if the insured person dies within the term. This type of policy can be suitable for spousal protection during a specific period, such as when children are young or when there are outstanding debts, such as a mortgage.
• Whole life insurance: Whole life insurance provides lifelong coverage and accumulates cash value over time. It offers a death benefit to the surviving beneficiaries whenever the insured person passes away. Whole life insurance provides long-term spousal protection and financial stability.
• Universal life insurance: Universal life insurance is a flexible policy that combines a death benefit with a savings component. It allows policyholders to adjust premium payments and death benefits over time. Universal life insurance can be used for spousal protection while providing potential cash value growth.

Group life insurance through an employer

Typically, employers offer group life insurance to provide their employees with life insurance benefits. The coverage amount is often a multiple of the individual's salary or a predetermined fixed amount. 

Group life insurance policies are generally more affordable and easier to obtain than individual or joint life insurance policies, as the risks are spread across a larger pool of insured individuals and generally are not individually underwritten. The employer often pays premiums for group life insurance, although some plans may require employees to contribute as well. 

Group life insurance typically provides a death benefit to the designated beneficiaries in the event of the insured person's death while covered under the policy. However, coverage may cease when the person leaves the organization. Further, the amount of coverage provided might not be sufficient for the surviving spouse, so supplemental coverage may also be needed.  

Spousal rider

A spousal rider is an additional provision to a life insurance policy that extends coverage to the spouse of the primary policyholder. This rider allows the spouse to be included under the same policy, typically with a separate coverage amount. 

By adding a spousal rider, the primary policyholder can provide life insurance protection to their spouse without needing a separate policy. In the event of the spouse's death, the rider provides a death benefit to the primary policyholder. 

Spousal riders are often available for various types of life insurance policies, such as term life insurance or whole life insurance, and they provide a convenient and cost-effective way to ensure spousal protection within a single policy. Remember, the spouse must still undergo the underwriting process, although it might not be as extensive as the primary insured.

Spousal protection ownership structures

Ownership structures are an important consideration when your clients choose their life insurance products, and each can provide certain advantages and disadvantages. The two main structures include:

1. ‍Individual ownership: Oftentimes, an individual will own a life insurance policy on themselves and name their spouse as the beneficiary. This generally provides greater flexibility, as the policyholder can change the beneficiary designation anytime. For example, if a couple decides to divorce, the beneficiary may need to be changed from the ex-spouse to a child/children or other desired individual (or, in some cases, a charity). ‍
2. Cross-ownership: Spouses may elect to own a life insurance policy on the other spouse's life. In this arrangement, each spouse is the policyholder and the beneficiary of the other's policy. This structure allows for the exchange of death benefits between spouses, ensuring financial protection for the surviving spouse.

The Goodman Triangle

One potential pitfall that could arise when two partners elect to take out a policy on one-another is called a “Goodman Triangle," which occurs when there are three separate parties to the life insurance policy - the owner, the insured, and the beneficiary. This may arise if the policyholder wishes to name a beneficiary for a portion of the death benefit for someone other than themselves. 

Take, for example, a wife who owns a life insurance policy on her husband but names the child/children as the beneficiaries of the death benefit. If the husband dies, the IRS will consider the death benefit to the children a taxable gift from the wife, which could have adverse consequences. To avoid this trap, two of the three parties must be the same. So, in the scenario above, if the husband is the insured and the owner of his policy, he can name the children and wife as beneficiaries without creating a Goodman Triangle.  

Payout structure & tax implications

Life insurance policies offer different payout structures, each with tax implications:

• ‍Lump sum payout: With a lump sum payout, the beneficiary receives the full death benefit in a single payment. In most cases, the beneficiary's death benefit is tax-free and does not have to be reported as taxable income.‍
• Annuity payout: Some life insurance policies offer the option to convert the death benefit into an annuity, providing periodic payments over a specified timeline, which the policyholder can customize. A portion of each annuity payment may be subject to income tax for any interest income provided.

The ideal client profile for spousal protection

The ideal client profile for spousal protection in life insurance can vary based on individual circumstances, but some common factors must be considered. Here are a few aspects that may make someone a good candidate for spousal protection:

1. Married or in a long-term committed relationship: Spousal protection primarily aims to support a surviving spouse financially. Therefore, individuals who are married or in a committed relationship can benefit from considering life insurance for spousal protection.‍
2. Dependents or financial obligations: If there are dependents, such as children, who rely on the income or support of the insured, or if there are significant financial obligations like mortgages, loans, or debts, it becomes essential to protect the spouse from financial hardship in the event of the insured’s death.‍
3. Income disparity: When there is a significant income disparity between spouses, life insurance can help bridge the gap and provide financial security to the surviving spouse. It ensures the surviving spouse can maintain their lifestyle and cover expenses without the higher-earning partner.‍
4. Future financial goals: Couples with shared financial goals, such as saving for retirement or funding a child's education, can benefit from spousal protection. Life insurance can help ensure those goals are achievable even if one spouse dies prematurely.

It is generally advisable to consider life insurance early on, especially when significant life events occur, including getting married, having children, purchasing a home, or taking on substantial financial responsibilities like a business loan. 

Starting early often allows individuals to secure more affordable coverage as premiums typically increase with age and health risks. However, the timing can vary depending on personal circumstances, so assessing the need for spousal protection in consultation with a financial advisor or insurance professional who can provide personalized guidance is best.

Case study

John and Sarah are a married couple in their early 40s with two young children. John works as a software engineer, earning a higher income, while Sarah works part-time as a freelance graphic designer. They have a mortgage on their home, outstanding student loans, and credit card debt. They want to ensure financial security for each other and their children in case of an untimely death.

John and Sarah meet with their financial advisor, Tom, to discuss their goals. Tom researches available policies from various carriers and, based on their circumstances, advises them to choose a 20-year term life insurance policy with a death benefit of $1 million. This coverage will provide income replacement, debt repayment, and financial stability for Sarah and the children during their most financially vulnerable years.

In addition, Sarah opts for a spousal rider on John's policy. This additional provision extends coverage to her, providing a separate death benefit in case of her passing. It would ensure financial protection for John and the children if Sarah were to die before the term ends.

As their financial situation evolves, John and Sarah plan to regularly review their life insurance coverage with Tom to ensure it aligns with their changing needs. They aim to increase coverage as their income grows and reduce coverage when their debts are paid off.

John and Sarah have established a solid foundation for spousal protection and financial security by strategically utilizing term life insurance with a spousal rider. The policies provide income replacement, debt repayment, and support for their children's education and upbringing. Regular reviews, estate planning, and financial checkups ensure that their life insurance coverage aligns with their evolving needs and goals, providing peace of mind for the entire family.