Life Insurance

Many financial experts consider life insurance to be the cornerstone of sound financial planning. It can be an important tool in the following situations:

1. Replace income for dependents
If people depend on your income, life insurance can replace that income for them if you die. The most commonly recognized case of this is parents with young children. However, it can also apply to couples in which the survivor would be financially stricken by the income lost through the death of a partner, and to dependent adults, such as parents, siblings or adult children who continue to rely on you financially. Insurance to replace your income can be especially useful if the government- or employer-sponsored benefits of your surviving spouse or domestic partner will be reduced after your death.

2. Pay final expenses
Life insurance can pay your funeral and burial costs, probate and other estate administration costs, debts and medical expenses not covered by health insurance.

3. Create an inheritance for your heirs
Even if you have no other assets to pass to your heirs, you can create an inheritance by buying a life insurance policy and naming them as beneficiaries.

4. Pay federal “death” taxes and state “death” taxes
On Jan. 1, 2011, the estate tax returns. According to a new law enacted in December 2010, estates valued at $5 million or less are exempt from the tax. Estates worth more than $5 million are taxed at a 35 percent rate. Although there was no estate tax due in 2010, some heirs encountered larger-than-expected capital gains taxes upon sale of inherited assets. This was due to the requirement that the basis of such assets be carried over from the decedent to the heir.

With the return of the estate tax in 2011, the stepped-up basis on inherited property also returned. This means that an asset’s basis is its fair market value on the day of the original owner’s death.

5. Make significant charitable contributions
By making a charity the beneficiary of your life insurance, you can make a much larger contribution than if you donated the cash equivalent of the policy’s premiums.

6. Create a source of savings
Some types of life insurance create a cash value that, if not paid out as a death benefit, can be borrowed or withdrawn on the owner’s request. Since most people make paying their life insurance policy premiums a high priority, buying a cash-value type policy can create a kind of “forced” savings plan. Furthermore, the interest credited is tax deferred (and tax exempt if the money is paid as a death claim).

Life Insurance Types

There are two major types of life insurance—term and whole life. Whole life is sometimes called permanent life insurance, and it encompasses several subcategories, including traditional whole life, universal life, variable life and variable universal life. In 2003, about 6.4 million individual life insurance policies bought were term and about 7.1 million were whole life.
Life insurance products for groups are different from life insurance sold to individuals. The information below focuses on life insurance sold to individuals.

Term

Term Insurance is the simplest form of life insurance. It pays only if death occurs during the term of the policy, which is usually from one to 30 years. Most term policies have no other benefit provisions.

There are two basic types of term life insurance policies—level term and decreasing term.

• Level term means that the death benefit stays the same throughout the duration of the policy.
• Decreasing term means that the death benefit drops, usually in one-year increments, over the course of the policy’s term.

In 2003, virtually all (97 percent) of the term life insurance bought was level term.

Permanent

“What’s in a name?” When it comes to buying life insurance, everything is in the name. Permanent life insurance is one such example of a name you will hear when you are in the process of buying life insurance. But what does it mean?
Before settling on a specific life insurance policy you must analyze your family’s needs, both pre and post-death. There are two main types of permanent life insurance:
Whole life insurance – Caters to long-term goals by offering consumers consistent premiums and guaranteed cash value accumulation.
Universal life insurance – Gives consumers flexibility in the premium payments, death benefits and the savings element of their policy.
Read on to learn more about these policies and how to determine which one is best for you. (To read the basics on life insurance, see How Much Life Insurance Should You Carry?, Understand Your Insurance Contract and Life Insurance Distribution And Benefits.)
Features of a Permanent Life Policy
Basically, this type of life insurance provides lifetime coverage. It is typically comprised of two parts: a savings, or investment, portion and an insurance portion.
Due to the presence of the savings element, the premiums are quite high. Here, a part of your premium (after deducting the insurance expenses) is invested by your insurance company and the accrued interest builds up your cash value. For this reason, permanent life insurance is also known as cash value insurance.
The most important feature of a permanent life policy is that you can take a policy loan by borrowing against your cash value. Note that in a permanent life policy, face value amount is different from the cash value. Face value is the amount of insurance you have bought and that your beneficiaries will receive upon your death. Cash value is the accumulated savings that you can access in the future. (To find out more about your beneficiaries, see Problematic Beneficiary Designations – Part 1 and Part 2.)
To be able to borrow against the policy, you need to have a good amount of cash value as you can’t borrow against the policy’s face value. This option is quite favorable because the interest rates offered by the insurers are comparatively lower than prevailing market rates. If you default, the insurance company will use the cash value to cover the amount borrowed. The best thing is that you can get this policy loan without any restrictions on how to use it and without any of the hassles involved with credit checks.
Occasionally, your unexpected financial expenses don’t allow you to pay the premiums on time. If you do not have enough cash value, then non-payment of premiums can result in cancellation of your policy, or it may be converted into a reduced paid-up policy. Due to the strict guidelines of a permanent policy, the only safeguard here is the use of the stored cash value in the policy to cover the premium payment. You can use your cash value for premium payment to continue your insurance coverage. Here also, you need to make sure that your cash value has accumulated an ample amount of money.
In case you want to cancel your permanent life policy, you will get your cash value in hand and can use it at the time of emergency. You need to bear in mind, however, that permanent life insurance policies are specially made to be kept in force for the lifetime of the insured. It may be foolish to surrender your policy after five years, so be sure to consult your insurance advisor before taking this step. (To find out which policies are necessary, see Fifteen Insurance Policies You Don’t Need and Five Insurance Policies Everyone Should Have.)
Whole Life Insurance
Whole life insurance covers you as long as you live. You have to pay the same amount of premium for a specific period to receive the death benefit. Normally, this policy is kept in force for the rest of your life, regardless of how long you may live. This type of insurance provides life insurance coverage with a savings feature. As a result, you may end up paying higher premiums in the beginning compared to term life insurance. (To read more about insurance types, see Buying Life Insurance: Term Versus Permanent)
Here, your insurance company puts part of your insurance money in a high interest bank account. With every premium payment your cash value increases. This savings element of your policy builds up your cash value on a tax-deferred basis. In a way, the presence of guaranteed cash values makes this policy worthwhile because you can borrow against your cash value or surrender your policy to get the cash value in hard cash.
You can also opt to participate in the surplus of your insurance company and receive the dividends annually. Here again, you have the choice to either get your dividends in cash, or let them accumulate interest. You may also use your dividends to reduce your policy’s premiums or buy additional coverage. Consult your insurance advisor before buying a whole life policy from a particular insurance company because dividends are not always guaranteed.
Whole life insurance is made to fulfill an individual’s long-term goals and it is important that you keep it in force for as long as you live. It is advisable to buy whole life insurance when you are younger so that you can afford to pay for it in the long term. Unlike term insurance, the level premiums, fixed death benefits and the attractive living benefits (like loans and dividends) make this policy quite expensive.
In conclusion, you practically pay premiums throughout your lifetime and make use of the cash value benefits while you are alive and upon death since your nominees get the death benefits. Whole life insurance is highly suitable for long term responsibilities like surviving spouse’s income needs and post-death expenses.
Universal Life Insurance
This policy is also termed “adjustable life insurance,” because it offers more flexibility compared to whole life insurance. You have the liberty to reduce or increase your death benefit and also to pay your premiums at any time and in any amount (subject to certain limits) after your first premium payment has been made.
Here, you can increase the face value of your insurance coverage. But, you need to pass a medical examination to qualify for this benefit. Similarly, you may decrease your coverage to a minimum amount without surrendering your policy. However, surrender charges may be applied against the cash value of your policy.
When it comes to the death benefit, you have two options – a fixed amount of death benefit or an increasing death benefit equal to the face value of your policy, plus your cash value amount.
You also have the opportunity to change the amount and frequency of premium payments. So, you can increase your premiums or may also even pay in lump sum according to the specified limit in the policy. As you know, part of your premium minus the cost of insurance is put into an investment account and the interest therein is credited to your account. In this way, the interest grows on a tax-deferred basis, which increases your cash value.
In case of a financial hitch, you can reduce or stop your premiums and use your cash value to pay premiums. Nevertheless, there should be enough money accumulated in your cash value account to cover the premium payments. Make sure to discuss the status of your cash value fund with your insurance advisor before stopping the premiums. Your policy may lapse only if you have ceased to pay premiums and have insufficient cash value to cover the cost of insurance.
The alternative of policy loan is an added perk in universal life insurance. It is significant that you do not make repeated withdrawals from your accumulated fund. This may reduce the cash value amount and will render you helpless at the time of genuine need.
Another good thing about universal life insurance is that your insurance company discloses the entire cost of insurance to you. This gives you an idea on how your policy works.
The downside of a universal life insurance is the interest rate. If the policy performs well, there are chances of potential growth in savings fund. On the other hand, the bad performance of your policy means the estimated returns are not earned. Hence, you end up paying higher premiums to get your cash value account going. Second, surrender charges may be levied at the time of terminating your policy or withdrawing money from the account.
Universal life insurance offers all-round protection to your loved ones, thanks to its security, flexibility and variety of investment options. In times of low liquidity, you can alter your premium payments or may even withdraw from your cash value fund. In addition, you can increase or decrease the face value of your insurance as per your circumstances.
Conclusion
When buying a particular life insurance policy, top priority must be given to your family’s pressing needs. Permanent life insurance is designed to give you and your family lifelong security. Whole life insurance protects your beneficiaries in your absence and acts as an asset-accumulating tool, while universal life insurance gives you the chance to regulate your insurance coverage in keeping with your current condition. Of course, your insurance advisor is always there to help you pick a policy, but in the end, it is you who has to decide what is suitable for you and your loved ones.