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Taking Care of Mom and Dad: Two Basic Functions

Life insurance can be used as an investment...and it offers some tax breaks. But its basic purpose is to provide two things: income replacement and liquidity in the event of the policy owner's death.

Insurance can prevent a distressed sale of assets to raise cash for taxes or other costs. The proceeds can pay estate taxes, debts belonging to the dead person and cash to survivors.

No matter how hard it may be to think about, considering the costs related to death -- medical, funeral and burial -- is also necessary when it comes to dealing with aging parents. These costs can be surprisingly large and put an enormous amount of pressure on emotionally-sensitive family members following the death of a parent.

Funeral and burial is the third-most expensive purchase an older adult will make, following a home and an automobile, according to the AARP. According to a study released in 2002 by the National Center for Policy Analysis in Dallas, a senior near the time of his or her death can generate more than $50,000 in medical, funeral and burial costs.

Although Medicare and Medicaid cover an estimated 65 percent of and older person's medical costs, survivors can expect to owe an average of $5,700 after that older person dies. And funeral costs can run about $6,130 -- with a burial adding $2,000 more than that. (These estimates come from the National Funeral Directors Association.)

Clearly, it's good to have some insurance in place to help pay these bills.

A major advantage of life insurance is the income tax-free transfer of proceeds to the beneficiary. This is widely known to the public. What the public doesn't always appreciate is that the insurance proceeds can be included in a dead person's estate, if that dead person owned the policy (even if someone else gets the money).

Example: Mom owns a life policy on Dad, with the children as beneficiaries. She pays premiums with her own separate funds, so that Dad won't be deemed by the IRS to have strings attached. The proceeds of the policy, therefore, will not be included in his taxable estate. At Dad's death, the insurance money goes directly to the children. No estate tax is due (although Mom has made a taxable gift to the kids, for federal purposes, because she gave them the policy proceeds).

Life insurance proceeds pass to a spouse income and estate tax free (as can all other assets). However, if the proceeds go to an estate or to a family trust, etc., there are going to be taxes due. Local probate courts may also get involved.

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