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Term Insurance |
This
type of insurance provides pure death protection, for a specified period of
time, for a specific premium. It
has no cash value and is initially less expensive than other policies for the
same amount of protection.
Some
types of term coverage remain level with increasing premium.
Others
have a level premium with gradually decreasing benefits.
Term
insurance may be purchased in a separate policy or as a rider (supplement) to
one of the other forms of policies - frequently at a discount.
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Whole life |
This
type of insurance provides protection that can be kept for as long as you live.
Premiums are fixed. As the
policy ages, its “cash value” increases on a tax-deferred basis.
If you cancel your policy, you receive the cash value that has
accumulated. While you continue to
own the policy, you can borrow against the cash value at a favorable rate.
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Universal life |
This
type of insurance adds savings flexibility to the whole life concept of
permanent protection. In general, a
policyholder must pay a certain minimum premium (for death protection) but can
increase the premium, almost at will, in order to increase the savings aspect of
the policy. The cash value will
increase based on current interest rates and the amount of premium going toward
the savings or investment portion.
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Variable life |
This
type of insurance combines flexible investment opportunities with insurance
protection. Owners have the
opportunity to obtain higher cash values and death benefits by their investment
results. Owners can choose between
a variety of fixed income or equity sub-accounts and make changes in the future
at no cost.
Term
insurance is best suited to solve a temporary need.
For example, you can use the death benefits to provide enough funds for a
college education or to pay off the mortgage on your house. Because it is death-only protection, it is less expensive and
therefore, more attractive if you are relatively young.
Whole
life insurance is best suited for older individuals with a permanent need. For example, whole life can be used to provide funds for
paying estate taxes or buying a partner’s business interest if your partner
dies before you.
Universal
life is for those who want to maintain flexibility concerning both premiums and
death benefits. It is also well
suited for those who want to build up cash values conservatively.
Variable
life is used by those who want to maximize their ability to use insurance as a
tax-deferred investment vehicle.
A
commonly quoted rule-of-thumb is that life insurance should equal at least six
times your annual after-tax income. However,
the real answer depends on your needs and your unique family, business and
financial circumstances.
Most
people buy life insurance for the following purposes:
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Ongoing
needs for support, as a replacement for the deceased’s paycheck. |
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Immediate
cash needs for such expenses as taxes, debts, burial, and estate settlement
costs and taxes. |
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Future
financial needs such as college costs and retirement income. |
To
determine the amount of insurance you should have, it is necessary to list all
of your financial needs and then perform the calculations.
This is where your professional advisor can be of assistance.
Many
estates, composed primarily of assets such as closely held business interests,
real estate or collectibles, are cash poor.
If your heirs need cash, these assets can be hard to sell. For that matter, you may not want these assets sold.
Insurance
can provide the necessary liquidity for your assets.
Therefore, even when the value of an estate is substantial, insurance is
often purchased simply to avoid the unnecessary sale of assets to pay taxes and
other expenses. The biggest
purchasers of life insurance are wealthy persons.
What good is a substantial estate if it is badly eroded by taxes?
Life
insurance is typically owned by the person whose life is insured.
That person usually pays the premiums and controls the designation of the
beneficiary. However, there’s a
potential problem if you own life insurance policies at death:
the proceeds will be included in your estate, possibly creating hundreds
of thousands of dollars of unnecessary taxes.
While there are no income taxes on the proceeds, the estate taxes start
at 18% and increase to 55%.
Instead,
you can create an irrevocable life insurance
trust.
The trust owns the policies and pays the premiums.
When you die, the proceeds pass into the trust and are not included in
your estate. The trust can be
structured to provide benefits to your surviving spouse and/or other
beneficiaries.
A
properly structured trust could save you more than 50% in estate taxes on any
insurance proceeds. Thus, having a
$1 million life insurance policy owned by an irrevocable insurance trust could
reduce estate taxes by more than $500,000.
Setting up these trusts can be complicated - be sure to get professional
advice beforehand - but it is certainly worth checking out.
The
main reason some couples carry life insurance is to pay estate taxes.
Because a properly structured estate plan can defer all estate taxes when
the first spouse dies, estate liquidity insurance is not needed until the second
spouse dies.
Second-to-die
insurance
pays off only when the second spouse dies.
Because it is based on the mortality of two lives instead of one,
premiums are usually significantly lower than on a standard policy.
Policies
may be combined to reduce costs and suit other customer’s needs.
One popular feature is the addition of an inexpensive term rider to cover
the insured’s children. Another
technique is to have both spouses insured by the same policy, thereby reducing
the policy administrative costs.
Types
of coverage may also be combined. For
example, suppose a person wanted to have the flexibility of variable life
insurance with its ability to increase or reduce the premiums and to shift the
investments around within the sub-accounts offered by the insurer.
Also, imagine that the amount of coverage required dictated the use of
term insurance. Both objectives can
be achieved by adding a term rider to a variable life policy.
The term premium would be low, and the coverage could be converted.
This approach also works with traditional whole life and universal
interest sensitive policies.
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Protection
for a limited time - generally to 70. |
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Low
initial premium, but rising with each renewal. |
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Level
Death Benefit, unless a reducing benefit plan. |
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No cash
values will accumulate. |
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Protection
continues to age 100, thus the permanent name. |
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Premium
does not increase; may even reduce or cease. |
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Level or
increasing death benefit. |
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Cash
values accumulate on a tax-deferred basis. |
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Protection
continues to age 100. |
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Premium
amount is flexible, may reduce, and could increase. |
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Death
benefit is flexible, can be reduced if desired. |
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Cash
value growth reflects the interest rate environment. |
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Policy
owner may alter structure to suit future needs. |
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Protection
continues to age 100. |
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Premiums
can be fixed, but are generally flexible. |
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Death
benefit is flexible, can be reduced if desired. |
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Cash
value growth reflects equity (stock) environment. |
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Policy
owner may alter structure to suit future needs. |
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Policy
owner may shift investments for diversification. |
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