Life Insurance-Who Needs It?
Life insurance is a complex and often misunderstood financial vehicle. In order to make an informed decision about the type and amount of life insurance to purchase, the insured’s personal and financial goals, available resources, and tolerance for risk should be evaluated. When considered in the context of an overall financial plan, life insurance can be used to accomplish a variety of goals:
•
Survivor Needs - Life insurance can provide funds for specific
needs
( i.e., college costs, mortgage payments, medical expenses)
•
Estate Planning - Proceeds from a life insurance policy could be
used
to pay
estate taxes; thereby, other estate assets (i.e., family
residence,
closely held business) would not have to be sold in order to pay taxes.
• Charitable
Purposes - Creating a legacy for a favorite
charitable
organization
could be the primary reason for purchasing life
insurance.
•
Wealth Creation - Insurance can be means of creating family wealth.
• Supplemental
Retirement Benefits - Life insurance receives tax-favored
treatment in
the buildup and distribution of accumulated cash value.
Amount of coverage - To determine the amount of insurance needed, analyze anticipated expenses and consider sources of income available to meet those costs. Life insurance needs change over time-the age of the insured will impact the amount of coverage. A reassessment of insurance coverage would be prudent following events such as a marriage, birth of a child, changes in children’s needs, and growth in personal wealth. Common formulas or “rules of thumb” to consider when determining how much life insurance to buy include (1) purchase coverage equaling 8 to 10 times insured’s salary, plus all debt and specific needs, (2) calculate the present value of estimated lifetime earnings to arrive at the lump sum needed today to generate those earnings (income approach), and (3) compute future expenses, subtract available resources, and calculate present value of net needs (needs analysis), Of these 3 methods, the needs approach is the most accurate for determining the amount of insurance needed to provide for future financial requirements.
Term Insurance - There are 2 basic types of life
insurance-term and permanent insurance. Term insurance provides a death benefit
during the life of the policy, but there is no buildup of cash value (term
insurance is considered “pure insurance”). Premiums for term insurance are
significantly lower than those for permanent insurance when the insured is young
or during the early years of coverage; however, premiums escalate over time.
Term insurance is generally most appropriate for specific short-term
needs.
There
are several term products available. The most common is Annual Renewable
Term - even though premiums increase each year, these policies can
generally be kept in force without requalification until the insured reaches an
advanced age (i.e. 75 to 80). Level Term policies have a fixed
(guaranteed) amount of coverage for a specific period of time (usually 5,10, or
20 years). In Decreasing Term insurance, the level of coverage declines
gradually over the term of the policy, but premiums remain at a constant level.
Renewable Convertible Term insurance provides renewable coverage and
the option to convert to permanent insurance at any time.
Permanent Insurance - This type of insurance is generally appropriate for long-term needs (e.g., estate and retirement planning). There are 2 basic types of permanent insurance-whole and universal life. Whole Life insurance is a cash value policy with a fixed death benefit that endows at age 100. Premiums usually start higher than term insurance premiums, but payments are at a fixed level for the insured’s life. A minimum cash surrender value is usually guaranteed, and the insured can borrow against the cash surrender value. In some cases, the insurer pays dividends to policyholders (which can be used to purchase additional coverage). Universal Life insurance is also a cash value policy; however these policies permit the insured to adjust premium payments (within limits) and increase/decrease the death benefit. A universal policy’s death benefit can also increase or decrease with changes in the policy’s cash value. There is usually a guaranteed minimum schedule of cash values and death benefits. Because the insured earns market rates of interest on the policy’s cash value and shares investment risk with the insurance company, universal life premiums are generally lower than whole life premiums, but higher than premiums for term insurance.
Variable Option - Variable insurance (whole or universal) allows the policyholder to select investment vehicles (i.e., stocks, bonds, money market funds) for the insurance contract. Consequently, cash values or variable policies are not guaranteed and will fluctuate with investment performance (i.e., the insured absorbs the investment risk).
General Guidance - Following are some guidelines for selecting life insurance products. As discussed above, life insurance decisions should be tailored to specific goals and financial needs (including time horizon and risk tolerance).
Short-Term
Need Medium-Term
Need
Lifetime
Risk
Tolerance (Up to 10
Years) (10-25
years)
Need
Aggressive
Term Variable
Whole Life
or Universal
Life or
Universal
Life
Variable Whole Life
Moderate
Term
Whole Life or Universal
Life Whole
Life
Conservative
Term Whole
Life
Whole Life
Accelerated Death Benefits - Enacted as part of the Insurance Portability and Accountability Act of 1996 , certain policyholders can receive tax-free accelerated death benefits. Proceeds from the sale or assignment of a life insurance contract to a licensed settlement provider (or an individual who meets certain insurance regulations) will be tax-free. Accelerated payments are available for 2 types of policyholders-(1) terminally ill patients (physician certified illness reasonably expected to cause death within 2 years), and (2) chronically ill individuals (generally, a person who cannot perform at least 2 activities of daily living--eating, toileting, transferring, bathing, dressing, continence). These rules became effective January 1, 1997.
These are some thoughts to consider regarding life insurance coverage.
We are glad to announce that Howard Lisch, due to popular demand, is now a licensed life insurance agent and is able to satisfy your life insurance needs as well as other investment needs.
If you have any questions about this or any other financial matters, please call me