Life insurance is frequently used to:
- Replace lost income for the surviving spouse and/or children.
- Pay for final expenses like funeral costs, burial and unpaid bills like a car loan or medical bills.
- Debt elimination like a mortgage or provide monthly income to cover a rent or pay a mortgage if the surviving spouse does not want to pay off the mortgage in a lump sum and loss the tax deduction for the mortgage payments.
- Pay for long term care expenses like care at home or in an assisted living community. Available in permanent life insurance policies if selected as an additional benefit.
- Estate liquidity to pay federal and/or state estate taxes or unpaid income taxes.
- Business uses like succession and continuity planning and key person insurance
There are two types of life insurance:
1. Term life insurance – this insurance only pays a cash benefit (known as the face amount of the policy) when someone (the insured) dies. You select the face amount – how much money you want to leave your beneficiary. Do you want to leave $500,000 or $1 million or more?
- You also select the period of time that you want coverage. Do you want coverage for a 10 year period of time where the face amount and the premium remain level for 10 years? Want a longer period of time like 20 or 30 years?
- The advantage of term life insurance is its cost. It has the lowest premium of life insurance since there is no cash value like you have in permanent life insurance that is outlined below.
- You can also insure your spouse and your children on the same application when you apply yourself.
- There will be higher premiums for older people and in some states like NewYork, term life insurance must end at age 80.
2. Permanent life insurance – this insurance offers you both death protection to your beneficiary and cash value (cash that belongs to you) over your lifetime. There are several different types of permanent life insurance.
Whole life insurance — called whole life because you have coverage for your whole life. Whole life is offered by both mutual life insurance companies (owned by the policyholders) and stock insurers that is owned by the shareholders. Mutual life insurers offer annual dividends (not guaranteed) to its policyholders as well as guaranteed cash value each year. Stock life insurance companies provide guaranteed cash value.
- Stock insurers offer lower annual premiums than the mutual life carriers since they do not pay dividends to its policyholders. Policyholders with mutual insurers will enjoy higher amounts of cash values over the years but will pay higher premiums than similar policies from stock insurers.
- What is your objective? Lower premiums today from a stock insurer or higher cash accumulation amounts later from a mutual insurance company? By the way, whole life insurance dividends are always free from both federal and state taxes!
- Need cash now? You can borrow cash from the policy if the policy has cash value. You will be charged an interest rate on the unpaid loan amount. You can also withdraw cash from your accumulating dividends.
Universal life insurance – is a permanent policy that allows you to customize your policy’s face amount (death benefit) and your premiums to meet your needs. It has a choice of two death benefits (level or an increasing face amount) and a flexible premium (pay more or less than the planned premium within certain limits). It also has a lot more moving parts than whole or term life insurance…read more involved than whole life.
- Your premiums are paid into the cash account where it earns interest (always has a guaranteed minimum interest rate like 2 or 3%). Monthly deductions from the cash account are made to pay for expenses like the charge for the life insurance protection.
- You can also take loans from the cash value and also do partial cash withdrawals. Both of these activities will reduce your death benefit and the cash value. Loans can be repaid (cash value and death benefit will be restored). Partial cash withdrawals cannot be repaid.
- Carriers today are offering universal policies that contain a guaranteed face amount as long as you pay certain minimum annual premiums even if the cash value goes to zero.
- Usually has the lowest annual premium among the permanent life insurance policies.
Variable universal life insurance — like the other permanent life insurance policies, variable universal life insurance also builds cash value but in a different way than whole life or universal life insurance.
- Policyholders direct where they want their cash to be invested. There are over 30 separate accounts to choose. Choices include a wide range of equity and fixed income accounts, money market accounts, real estate trusts and other alternative investments.
- The policyholder assumes the investment risk(risk of the cash value). Good investment performance will move the cash value and the face amount higher over time. Of course, the reverse can also happen when investment returns decline.
- Like universal life insurance, you will have a choice of death benefits (either level or increasing) and flexibility on how much you want to pay towards the premium.
- Many policies will also guarantee the face (death) benefit as long as the annual premium is paid.
- Quinlan Care does not offer this type of policy.
Survivorship life insurance – you and your spouse have done well financially with a net worth well in excess on $10 million. Your estate will be subject to federal estate taxes and possible state estate/death taxes that can exceed 45% of your estate. One popular solution to pay these estates taxes is to purchase a life insurance policy called the survivorship life insurance policy or called the ‘second to die’ life insurance policy.
- It gets it name because the death benefit is only paid upon the death of the second spouse. Estate taxes are generally due on the passing of the second spouse.
- You will buy this policy to avoid a ‘fire sale’ of your assets to buy the estate taxes, generally due 9 months after the passing of the second spouse. The policy proceeds will provide liquidity to pay the estate taxes.
- You can purchase a whole life, universal or variable universal survivorship policy.
Tax advantages of Life Insurance
There are several tax advantages when you purchase life insurance:
- Tax deferred growth of the inside build up of cash value in a permanent policy while a policy is in force.
- Policy loans are generally income tax free from permanent life insurance policies
- Death benefits that are received in the form of a lump sum payment are income tax free. They may be subject to estate taxes if the policy is owned by the insured.
- When you withdraw money from a permanent life insurance policy, the amount you paid into the policy as premium (called your cost basis) is first withdrawn tax free. The amount withdrawn that exceeds the policy’s cost basis is taxable.
- Dividends are income tax free in a whole life policy.
Consumer tips when purchasing or owning life insurance:
- Life insurance should never be purchased nor sold as an investment. It is a risk management tool to reduce the financial loss when someone dies.
- Make sure that you understand the inner workings of the life insurance policy that you are thinking about purchasing.
…How does it work and perform today? 5 years from now? 20 years from now?
…What are inherent risks in the policy? Is your policy’s cash value depend on an interest rate? Changes in the stock or bond market? What will happen to my policy’s dividends when interest rates fall or rise?
…What happens to your policy’s face amount (death benefit) if interest rates or the stock/bond markets rise or fall today? 10 years from now?
…What happens if I cannot make a premium payment today? How long is the grace period? What if I become disabled and can’t work?
…Can your premiums increase in future years? If yes, by how much?
…What happens to my policy’s face amount and cash value if I stop paying the premiums today?
…Have there been major changes in my life like a death of a beneficiary, divorce, disability, a need for cash (i.e. tuition or an emergency) or a terminal illness?
- You and your insurance agent/broker should review your policy annually.
- Always notify the life insurance carrier in writing of any changes to your beneficiary designation and mailing address.
IMPORTANT –always consider adding two riders to your policy, usually done at the time of the application. A rider generally adds a benefit to your policy. The first rider (for an extra premium) is a waiver of your premium in the event of a disability.
The second benefit is called the accelerated death benefit (also know as the living benefit). This feature will allow you to withdraw up to 60% of the policy’s face amount if you are terminally ill — within 12 months of dying. This benefit is income tax FREE and premium FREE. It may be a rider (always select it) or it may be built into your policy. Always get this benefit!