Brian's Blog: Thoughts on Estate Planning, Business, Asset Protection, Family & California Life

The Life Insurance Debate: Term vs. Perm. (by Rich Rojas)

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.

How Your Life Insurance Policy Can Ruin Your Child's Life (Or At Least His Marriage)

I cannot overemphasize how important having the right insurance coverage is.  If you have a minor child, it is especially critical that you work with a good life-insurance advisor.  It's how you can ensure that your child's legal guardian will have the resources to adequately care for your child if the unthinkable happens to you.   

Of course, as a thoughtful parent, you'll want to do more than just invest in a good life insurance policy.  You'll also want to make the right decisions about how the proceeds of that policy pass to your child.  In part, that means avoiding three very big planning mistakes. 

Mistake One:  Making Your Child's Legal Guardian Your LIfe Insurance Beneficiary.  You should avoid making the benefits of your life policy payable outright to your child's guardian if something happens to you.  Once that money is distributed to the guardian, it's the guardian's money (i.e., not your child's money) in every legal sense. 

Why is that a problem?  Well, what would stop the guardian from betting it all at the local race track in a moment of weakness?  Similarly, who would prevent the guardian from spending it all on himself or giving it all away to her favorite causes?

Even if your child's guardian is the most reliable and trustworthy person on Earth, having him or her be the beneficiary of your life insurance policy is not a good idea.  The guardian could still lose the insurance money in a lawsuit, even one that has nothing to do with your child.  Plus, if the guardian goes through a divorce, half of the insurance proceeds would probably leave with the ex-spouse.  Finally, any money that's left over if the guardian passes away would be includable in his or her estate for tax purposes, meaning a good chunk of it could go to the government instead of your child (assuming the guardian chooses to leave it to your child).    

Mistake Two:  Making Your Minor Child Your LIfe Insurance Beneficiary.  If you pass away and your child is the beneficiary of your life policy, the proceeds must go into a guardianship estate supervised by the probate court.  Your child’s legal guardian will then have to wait six months or more every time they need to be reimbursed for an expense. That can cause real hardship for your child and their caregiver. Plus, there will be accounting fees and other costs associated with maintaining the guardianship estate.

That’s very bad, but it’s not the worst consequence of designating a minor child as your life insurance beneficiary.  No, the worst consequence is that your child will get whatever insurance money is left over when he or she turns 18 –- no strings attached!

A quick story illustrates just how destructive that kind of inheritance (i.e., an "outright" inheritance) can be. When he was 18, my friend's ex-husband inherited $150,000. His life was so easy at that point that he never learned to budget or manage money.  Instead, he got married (too young) to my friend, blew his inheritance, and fought with his wife quite excessively about their finances.  Years later, my friend is convinced that a major factor in the demise of her marriage was that outright inheritance at the wrong time.

And that is how your life insurance policy can ruin your child's life (or at least his marriage).

Mistake Three:  Not Planning So Your Life Insurance Proceeds Go Tax-Free To Your Child.  Many people believe that life insurance is entirely tax free to the owner.  It isn't.  Unless you do the right kind of estate planning, up to 45% of the proceeds could be lost to the government in the form of estate taxes.  You aren't paying those premiums simply to increase the public coffers, right? 

Fortunately, there is no reason why you need to make any of the mistakes identified above.  Your minor child should and can benefit from every penny of life insurance you buy.  If you want absolute peace of mind when it comes to protecting your child fully, please contact us. Together we can ensure that your child's guardian has the legal responsibility to use your life insurance to care appropriately for your child.  We can also make sure that whatever money is left when your child grows up goes to him or her in exactly the right way.  In fact, we can even protect that money from lawsuits, divorce and estate taxes.  We can do all of this through the right combination of one or more carefully drafted trusts and your policy's beneficiary designation form. 

But the time to plan is now.  Life insurance only gets more expensive as time passes.