Imagine this: your friend John has proven himself to be irresponsible with his family’s finances. He always has maxed-out credit cards and spends more than he makes every month. John’s financial management is atrocious.
Let’s say Cindy is married to John, and they have three kids. Cindy is frustrated by John’s lack of self-discipline when it comes to money. If you were Cindy and found out that John had just inherited a considerable sum of money, would you want it paid out to him in a lump sum or paid out in smaller monthly installments?
Jump ahead to these sections:
- Family Income Policies Defined
- How Do Family Income Policies Work?
- Pros and Cons of Family Income Policies
- Who Typically Benefits From Getting a Family Income Policy?
- What Are Good Alternatives to a Family Income Policy?
The chances are very good that Cindy would want John to have a monthly income instead of a lump sum payout. John’s a good man, but he’s a terrible money manager.
Change the scenario a bit, and imagine that John didn’t inherit the money. Instead, he was the beneficiary of a life insurance policy with a death benefit of $1 million. In this case, how could John be paid?
The answer: a family income insurance policy. Below, we’ll detail what a family income life insurance policy is, how it works, and more.
Family Income Policies Defined
Life insurance companies developed an insurance product designed to help beneficiaries like John, who aren’t great a money management, handle the death benefits they receive; it’s called a family income policy.
Instead of paying a lump sum to the beneficiary of a life insurance policy, the insurance company pays a monthly income for a set period of time. In cases like John’s, a loved one can select this type of policy for the beneficiary’s protection.
A family income policy is different from a family maintenance policy. Not only does a family maintenance policy pay out a monthly income for a period of years, but it also pays a lump sum benefit when that period has expired.
How Do Family Income Policies Work?
A family income policy is a form of term life insurance. With standard term life, the insurance protection is in force for a set term of years. If the insured person dies within that fixed term, the insurance company will pay a death benefit to a named beneficiary. However, the policy expires if the insured person outlives the term, and no death benefit will ever be paid.
Another type of term life insurance policy is called decreasing term life insurance. With decreasing term, the death benefit decreases over the life of the policy. For example, the death benefit in year one may be $100,000, but it is only worth $50,000 to the beneficiary in year ten.
It’s important to note that a family income policy is a type of decreasing term life insurance. Unlike standard term life insurance, which pays out a lump-sum benefit, a family income policy will pay out a monthly income, with the amount which would be paid to the beneficiary decreasing the longer the policy is in force.
For example, Jane wants her spouse and children to receive $5,000 per month to replace her lost income when she dies. Because her family income policy is decreasing 20-year term insurance, the death benefit of $1 million decreases the longer she lives. If Jane dies five years into a 20-year policy, that policy will pay out $5,000 for the next 15 years (a total of $900,000 paid out to her family).
However, if Jane dies after the policy has been in force for 15 years, the $5,000 benefit will only be paid out for five years (a total of $300,000 paid out to her family).
In the above example, if Jane had taken out a family maintenance policy instead of a family income policy, her family would not only receive the monthly payout for the balance of the term, but they would also receive the face amount of $1 million when the payments end. This sounds like a much better deal, but remember that a family maintenance policy costs more per month than a family income policy.
Pros and Cons of Family Income Policies
Like any financial product, family income life insurance policies have pros and cons. Let’s look at both.
Pros of family income life insurance
On the plus side, family income policies take away the stress of deciding what to do with a significant death benefit. For example, in Jane’s case, if the $1 million benefit was paid in a lump sum to her family, who only needed $5,000 per month to replace her income, they would have to evaluate many options before choosing how to invest the surplus, and with whom.
A family income policy makes it much easier on the survivors. Jane’s family only needs $5,000 per month to make up for her lost income, and that’s what they’ll be receiving. At a time when their world has already been turned upside down by Jane’s death, they won’t have the additional pressure of having to decide what to do with a large sum of money.
Another plus of family income policies is how they can help families with young children. Because the policy is decreasing term life insurance, the death benefit will be higher when the kids are young, but it will decrease as the kids grow older and will ultimately end when the last one is out on their own. If the insured doesn’t die and the policy expires, the kids will be grown, and the policy owner will no longer have to pay the life insurance premium.
Cons of family income life insurance
There’s also a pretty substantial downside to a family income policy: the decreasing death benefit. For example, if death occurs in the early policy years, the larger payout may serve to fund a five-year-old child’s future education, but it may not help pay college costs if the insured dies with only three years left on a 20-year policy term.
Also, it doesn’t mean the surviving spouse won’t need financial help maintaining their lifestyle because all of the children have moved out of the house. There may still be a house payment and other debts to be paid, as well as ongoing monthly expenses. If the surviving spouse is unable to work, they could face a financial disaster if they relied solely on the family income policy.
Who Typically Benefits From Getting a Family Income Policy?
The primary reason why life insurance can be important to a family is to replace the lost income of one of the breadwinners. When a contributor to the family income passes away, it can dramatically affect the surviving family members, not only emotionally but also financially.
A two-income family can rarely survive on only one income. The monthly income that comes from a family income policy can mean the difference between a family being able to continue to live in their home or having to leave that security behind because the surviving spouse can’t make the house payment on their own.
If the kids are grown, a family income policy can also benefit the surviving spouse, as there might be medical bills and final expenses that need to be paid.
What Are Good Alternatives to a Family Income Policy?
In this article, we’ve talked about standard term insurance and decreasing term insurance. The big difference between the two is that the death benefit from the decreasing term policy will be worth less over time and will ultimately expire.
Permanent life insurance with a family income rider
A good alternative to a term life insurance policy would be a permanent life insurance policy with a family income rider. Permanent life insurance, such as whole life, maintains a level death benefit for as long as the premium on the policy is paid. It doesn’t have an expiration date.
A whole life policy allows you to add certain riders to the policy, including a family income rider. The policy’s beneficiary would not only receive a lump-sum death benefit, but they would also receive monthly income payments over a term of their choosing, which can even be for the rest of their life. The lump-sum death benefit would be paid at the beginning of the monthly income payments, not at the end like a family maintenance policy.
Annuity
Another alternative is for the beneficiaries to receive the death benefit of either a term or permanent life insurance policy in the form of an annuity. An annuity pays an income stream based on the amount of the policy’s death benefit over a term that the beneficiary chooses (usually 10-20 years, but can be lifetime), the same as with a family life policy, but the beneficiary receives the total amount no matter when the insured dies.
The insurance company makes the annuity payments, but there are tax and investment considerations that should be discussed with a financial advisor or accountant before selecting this option.
Trust
One last alternative is to have the death benefit paid into a “spendthrift trust.” This type of trust gives full authority to an independent trustee to pay out the death benefit as they see fit.
Their decisions on how much to pay out at a time and when are to be made in the beneficiary's best interests. This would be an excellent solution to prevent John, our spendthrift in the example earlier in the article, from making poor decisions when receiving the death benefit.
Is a Family Income Policy Worth It?
It’s important to remember that any check from a life insurance policy is accepted by the bank no matter what type of policy it came from (term, decreasing term, whole life, family income, etc.). What matters is that the beneficiaries are taken care of financially.
A family income policy is worth it if someone doesn’t have the ability or want the responsibility of managing a large, lump-sum death benefit. The alternatives we just looked at will be preferable in most situations, but a family income policy has its place under the right circumstances.
A financial advisor or professional life insurance agent can help you find a life insurance policy that will meet the needs of you and your family.