Life Insurance Planning

Most people don't like to contemplate death. We are all reluctant to think about the reality of leaving our loved ones behind. Unfortunately, far too many people delay estate planning until it is too late – they die unexpectedly, suffer serious health problems, or become incapacitated and unable to manage their own affairs. Drafting a carefully designed estate plan now, before it is too late, will give you peace of mind and help ensure your family’s financial future. Purchasing some form of life insurance can be one of the best ways to ensure your loved ones are protected after you’re gone.

To many people, life insurance is an intimidating and confusing topic. With so many different types of policies available, it can be difficult to determine which type of life insurance suits your needs. To make matters worse, aggressive insurance salespersons push products that may not necessarily provide a good return on investment. Before purchasing any type of life insurance, you should make sure you have a basic understanding of the various types of life insurance and whether they complement your individual needs.

The first step in contemplating any kind of life insurance is deciding whether you really even need it in the first place. Estate planning professionals generally recommend some type of life insurance policy for individuals with dependents – which can be a spouse, minor children, or both. Additionally, if you own a business, life insurance can help keep it functioning and solvent while your heirs or successors determine how to handle the transition after your death. If you are a single person with no children and don’t expect to leave any dependents or a sizeable estate behind, life insurance is most likely unnecessary.

Once you've decided to invest in a policy, you must next consider what kind of life insurance fits your goals. Life insurance is generally sold in two types: "term" and "permanent".

Term life insurance is the most basic, straightforward form of life insurance. It is also much cheaper than permanent life insurance, generally costing just a few hundred dollars per year. A term policy is designed for the specific purpose of providing your heirs with a lump sum payment when you die. Most term life insurance policies are available in periods of 10, 20, and 30 years, although policies can range anywhere between 1 and 30 years. As long as you die while the policy is active, your beneficiaries will receive the face value of the policy. For example, if you have a 20-year $100,000 term life insurance policy and die 8 years into the policy, your beneficiaries will receive $100,000. At the end of the term, the policy simply expires along with the death benefit. You receive no money at the end of the term. Most life insurance companies do not require a medical exam for term coverage as long as you are under a certain age. Because the likelihood of illness and death naturally increases as we age, older adults might find it difficult or simply impossible to purchase term life insurance. Term life insurance is a popular choice among parents of minor children who will need large expenses like college tuition covered in the event a parent dies prematurely. It could also be used to pay off a mortgage if you leave behind a spouse who would not otherwise be able to afford the family home.

Permanent life insurance, also commonly referred to as “cash-value life insurance,” is an entirely different type of coverage, combining life insurance with an investment element. Unlike term coverage, it never expires. A permanent life insurance policy’s death benefit is called its “face value” and, just like a term policy, your beneficiaries receive that amount if you die. The investment portion of permanent life insurance coverage is referred to as “cash value.” The cash value amount is the money you would receive if you cashed out the policy before it matured or simply stopped paying premiums – assuming you had paid in enough money to accumulate any cash value. Typically, your premium is divided into two parts, with one portion going toward life insurance and the other into some sort of investment account. For this reason, permanent life insurance premiums are much higher than term premiums.

Permanent life insurance comes in three flavors: Whole, Universal, and Variable. With so many choices, it can be daunting to decide which type to choose.

Whole life insurance comes with a death benefit and a tax-deferred cash value, which acts much like a savings account. The cash value component is funded by way of an annual dividend, which is deposited by the insurance company. Generally, the dividend varies between a set spread of percentage points but is guaranteed to never drop below a certain amount. The minimum guaranteed percentage point differs from policy to policy. Because it eliminates some of the risk element that accompanies most forms of long-term investments, the guaranteed minimum contribution amount is one of the most appealing aspects of a whole life policy. It is important, however, to ask your financial advisor to give you an idea of your likely earnings should your annual dividends drop to the minimum amount. Never base your investment decision on the best case scenario.

Universal life insurance differs from whole life in that it permits the individual to control how much money gets allocated to the different parts of the policy. For example, if the investment element is not earning a favorable rate, the policy holder has the option to adjust the premiums to direct more money to the life insurance account, which increases the death benefit. If, on the other hand, interest rates are very high, it makes more sense to apportion more money to the investment account, where the overall balance can continue to earn interest.

A Variable life insurance policy combines traditional life insurance with an investment portion that resembles typical investment products like stock options, money market accounts, and equity funds. One of the main criticisms of variable life insurance policies is the inherent risk in allocating part of the premium to investments that depend entirely on market performance. If the investments perform poorly and lose too much money, you might have to pay higher premiums in order to cover the life insurance cost. Failing to maintain the premiums could cause the policy to lapse, which could result in a very poor cash value payout or complete loss of the entire amount paid on the policy. Permanent life insurance policies also come with relatively high commission and administrative fees while offering limited control over the investment component.

Permanent life insurance has drawn a great deal of criticism by financial experts and professionals in the field. A common mantra is to “purchase term life insurance and invest the difference.” Simply put, this means that you’re likely to see a much more favorable return on your money by taking what you would spend on a permanent life insurance premium and investing it on your own. Permanent life insurance does have its uses, however, and can be a sound investment under the right circumstances. For example, parents of disabled children in need of lifelong care might consider some form of permanent life insurance to ensure a guaranteed death benefit. Permanent life insurance policies are also useful for people who anticipate having estate tax assessed against the property they leave behind. Because federal estate tax law has spent the last few years in a state of upheaval, it is difficult to speculate what estate tax rates will be in the future. Historically, however, the minimum taxable amount has been $1 million, which is not all that difficult to meet when you add up a lifetime’s worth of assets. Keep in mind, too, that most states have their own estate tax threshold, which is usually much lower than the federal amount. If, like many people, your wealth is tied up in real estate and other non-liquid assets, a permanent life insurance policy that quickly pays out a death benefit to your heirs can save your loved ones the hassle of selling off property to pay estate taxes.

No matter what your particular financial situation, you should at least consider some form of life insurance as part of an overall estate plan. It is never too early to begin planning for the future. An experienced estate planning attorney can offer you more information on the different types of life insurance products available and will work with you to select a policy that provides you ideal coverage. Unlike insurance brokers, estate planning attorneys do not have a personal interest in persuading you to choose one type of policy over another, so you get the added benefit of receiving unbiased advice.

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