There is no quick and easy answer to the ongoing debate on whether to buy permanent life insurance, term life insurance, or a combination of the two. Appropriate circumstances exist for each type of coverage. Determine the right amount of coverage you need today. The rule of thumb is any parent earning an income should have life insurance coverage to last until the youngest child completes college. Then decide if that amount will be enough for future needs. For example, will Junior opt for Harvard or Stanford, rather than Sac State? Will there be an inheritance which throws you into a different estate tax category? Do you have large financial obligations such as high credit card debt or a mortgage? You could use life insurance to ensure those and other debts are covered. Also, those who have a disabled child may want to assure that there are assets to provide for ongoing care. In that instance, permanent insurance is one way to assure assets will be there.
If you are in a higher tax bracket with high income and future estate tax worries, you may need permanent insurance. Since life insurance death benefits are exempt from federal income taxation, many financial planners often use clients' life insurance benefits to help pay the estate taxes. You should consult your estate planning attorney to determine whether your particular estate is likely to give rise to an estate tax issue.
TERM INSURANCE
Term insurance is by definition pure protection for a set dollar amount for a set number of years. If you prematurely die within the selected term of years, the policy pays an income tax free benefit to your beneficiaries. However, since these policies are designed to expire before you do, there is a greater than 95% chance that the term policies will not pay off. Why? Because the policy has either lapsed due to non-payment of premiums or the term of years has expired. In outliving the policy term you lose all of the premiums paid, just like your homeowner’s or auto insurance. Yet, for an income earning parent with few financial resources, the purchase of term insurance would be the likely recommendation.
It is easier to shop for term insurance because one typically looks to get the lowest premium for a given amount of coverage. Ideally, to make apples to apples comparison of policies one needs to be medically underwritten first. Health issues may increase the premium or disqualify one from purchasing a policy. Additionally, some companies underwrite certain health factors more favorably. Therefore, a random internet comparison of prices may give an inaccurate picture of who qualifies for what. It‘s the old bait and switch tactic. Promise the low prices first, and then tell them the bad news later.
PERMANENT INSURANCE
Permanent life insurance has features not found in term insurance. Assuming the premiums are paid, there is no expiration date on the policy. You essentially own the policy. Permanent insurance builds cash value and loans are permitted against it. The policy is considered an asset by the IRS and growth in the cash value is tax deferred. These benefits come at a price, however. The premiums can be 5-10 times higher than term insurance. There are three basic types of permanent insurance: whole life, universal life, and variable life. The two most common are whole life and universal life.
Whole Life
Whole life insurance provides lifetime protection, for which you pay a predetermined premium. Unless altered, cash values have a minimum guaranteed rate of interest and the death benefit is a fixed amount. Whole life insurance is the most expensive life insurance product available.
Universal Life
Universal life insurance separates the investment from the death benefit. The investment choices available usually include some type of equity investments, which may make your cash value accumulate quicker. You can change your premiums and death benefits to suit your current budget. Universal life has maximum guaranteed premiums and minimum guaranteed cash values and death benefits. Instead of dividends, universal life policies earn interest at the credited interest rate determined each year by the insurance company.
Variable Life
A useful way to understand a variable policy is to think of simultaneously buying term insurance and investing money in a mutual fund. Unlike traditional term or whole life insurance, variable life insurance allows the insured to choose how the premiums will be invested, usually from among 10 -15 funds. However, unlike a traditional mutual fund that may pass on capital gains and other income tax obligations annually, the investments in a variable policy grow on a tax deferred basis. And, as with any permanent life policy you are allowed to borrow against it. While there is no guaranteed cash value, there is a guaranteed minimum death benefit. If you consider yourself a knowledgeable and risk accepting investor, you may wish to purchase variable life insurance.
The comparison between the different types of permanent policies is difficult because these policies contain a variety of assumptions about mortality rates, expenses, and investment returns that affect the buildup of cash value. This means that the policy's cash value as well as the death benefit can fluctuate with the performance of the investments that the policy holder has chosen.
IN SUMMARY
Regardless of the type of policy you choose, you will have to undergo the medical underwriting process to determine if you qualify. Underwriters will check cholesterol and blood-sugar levels, medical history, drug and alcohol use and related issues, driving record, hobbies, and credit rating, among others. Factors such as age, tobacco use, and prior health issues can also drive up the premiums on a policy.
Life insurance can be an important tool in: 1) replacing income for dependents, 2) paying final burial costs, debts, and medical expenses not covered by health insurance, 3) paying estate taxes, 4) creating an inheritance for your heirs, 5) creating a source of savings, and 6) making significant charitable contributions by naming the charity as the beneficiary. Many financial experts consider life insurance to be the cornerstone of sound financial planning.
Richard Rojas is an independent insurance professional with Capital Planning Advisors in Sacramento and may be reached at 916-551-1930.
I think Mr. Rojas touches on many of the important aspects of life insurance which may help your blog readers/clients to decide on which product may be appropriate for their particular situation. I believe that many new products in the industry, like universal life policies with guarantees to age 120 with minimum premium payments may be an answer to those individuals seeking low premiums [otherwise term life insurance buyers] but have longer term protection needs [estate planning]. Eventually , and especially California homeowners, estates may be in excess of triggering death taxes that are over an above the protection afforded by the Federal Estate Tax Credit limits - whether repealed or not in 2010 (according to EGTRA 2001).
I believe the most important consideration is to have a professional advisor like Mr. Rojas to examine your needs carefully and then monitor your existing life insurance portfolio on a regular basis along with the counsel of an attorney. As new innovations in life insurance policies are introduced, those may be a better fit for the future needs of Mr. Rojas's clients. This warrants that Mr. Rojas's clients should follow-up every year or even more frequently to assure the correct life insurance is in place, if the health status of the insured has changed (in the case there is an opportunity to guarantee a conversion from a term policy to a permanent policy with the existing plan approaching the expiration of a term policy), and that beneficiaries are correct and current according to any wills or trusts that coincide with the advice of your attorney. Also in rare cases one may consider selling off their life insurance policy to a life settlement company if they need access to their policy values before death and their is a reduced need for survivor benefits over time. I give an A+ to Mr. Rojas on his article and appreciate his personal insight on the topic.
Wayne Dunbar, AALU, AIRC, AIAA, ACS
Posted by: Wayne Dunbar, AALU, AIAA, AIRC, ACS | August 29, 2007 at 11:29 PM