Why Senior Life Insurance Rarely Works As Planned

I was recently reading about something called senior life insurance plans (in some parts of the country, they are called graded death benefit plans). This has nothing to do with life insurance for seniors, but instead, refers to a type of policy that has a gradual payout structure that takes three to seven years for the insurance company to pay the beneficiary. In theory, this type of insurance is appropriate for people who want to provide for a beneficiary that will have trouble handling large sums of money so instead, the insured makes arrangements for periodic payments over time.

There is some variety regarding plan specifics, but generally, a senior life insurance plan is one that has a payout term of anywhere between three and seven years and offers nominal payments upfront.

For instance, let’s say you elect for coverage that gives you a $500,000 payout upon your death. Your son is your designated beneficiary, and you know that he would lose his mind over receiving that kind of money in a lump sum so you decide that you want a graded death benefit plan that won’t give him access to that $500,000 upfront.

Instead, the benefits come out in graduated amounts–he might collect $10,000 in year one, $10,000 in year two, $25,000 in year three, $25,000 in year four, $30,000 in year five, $30,000 in year six, and then $370,000 in year seven.

The paternalistic impulse that would make such a policy attractive is that the son would have seven years to prepare for the big pay day, and if the insured father dies while the son is in his 20s or younger, it also provides the opportunity for the son to mature and prove himself more mentally capable of receiving the proceeds.

There is just one catch. Social engineering rarely comes without unexpected side effects.

It is a constant theme that financial planners see over and over again—sedulous and cautious parents rarely produce children that share their same spirit of prudence. It is understandable why this narrative has a timeless element. If you don’t have a safety net, you know that you will have to work hard if you want to have nice things. If you are already born into a life of nice things, you don’t quite feel the incentive to produce that which you already have. This behavioral tendency is on my mind when I study the reality of how senior life insurance plans play out.

Among graded life insurance plans that payout less than half of the money within the first two years, the beneficiary rights to such a plan are sold to a third party in over 85% of the cases.

The real-life application is that the beneficiary does everything in his power to dodge dad’s intended life lesson about delayed gratification and the value of letting time pass before receiving the money. Instead, what happens is that the beneficiary quickly finds a way to get his hands on some quick by selling away his rights to someone who is patient to receive that $370,000 in year seven.

This type of actual behavior ends up thwarting the intentions of an insured individual who wants to find a way to apply the brakes on the self-destructive tendencies of his loved ones.

Basically, what ends up happening is that the beneficiary will settle for a quick $150,000 now instead of gradually waiting to receive the bulk of that $500,000 in 2024. It is a great deal for the well-financed third party who purchases the life insurance benefits from your son, and ends up receiving a guaranteed 18.77% annual return on their investment.

My view is that if you have a child that you believe will spend the insurance proceeds from your death immediately and you want to ward it off, I think it is better to write the life insurance in trust rather than set up something like a graded death benefit plan which in reality gets old to a third-party company for about thirty pennies on the dollar anyway.

When you put your life insurance proceeds into trust, the effect is the same as if you funded a trust fund with available capital that you have on hand while you are alive. According to Aegon Insurance, only 6% of those who take out a life insurance policy end up instructing the proceeds to go into a trust fund.

The number reason why they don’t do so? Because of cost. They don’t want to pay the 1.25% annual fees on that $500,000. Personally, I think the $6,250 in annual costs on a $500,000 plan is worth it. If that means that your child will get $15,000 paid out to him every year for life (a $750,000 value if he lives for fifty years after he dies, and then his kids also pick up where he left off), then this is much better consequence than the typical result in which your kid turns $500,000 in benefits into a quick $150,000 and then has nothing to show for it in a year or two.

I’ll put it another way. Even if you don’t like the thought of some financial advisor type collecting $6,250 from your insurance plan legacy, your son would have to live for 56 years in order for the financial advisor to collect as much as the third party that purchases the rights to the senior life insurance policy from your kid. At least in the case of the financial advisor, he is providing a regular ongoing service to your kid for over a half-a-century. When you look at the 85% of the cases in which the beneficiary sells his rights to a third party, the only thing that the third party provides is a one-time cash infusion before fading out of the picture entirely.

This is one of those circumstances when it is strongly in your interest to look at the world as it is rather than how you wish it would be. If you have enough concerns about any of your kids receiving a large lump sum payment that you are considering a senior life insurance policy for its graded benefit structure, then you should also recognize the substantial statistical likelihood that your kid is going to sell his rights under the policy rather than wait it out for seven years as you intended. For that reason, I would suck it up and tolerate the fees associated with putting the life insurance proceeds in trust. When it comes to things that involve large sums of money and the well-being of your family, you really need to be pragmatic rather than ideological.

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