Protecting your assets with insurance is often the best way to manage the biggest risks we face. Life insurance planning includes making sure that you are protected with the right type of policy, the right amount of insurance coverage, and that you’re not paying too much for it.
There are some GREAT tax advantages to owning life insurance products. First of all, death benefits are always TAX FREE to the beneficiary. This is a HUGE advantage over other types of investments. Also, life insurance products can build up cash value that grows tax-deferred, and can be used for tax-free loans by the policy owner. You can’t do that with your IRA, 401K, or brokerage account.
Life insurance products can be separated into two major categories: 1. Cash value or permanent insurance. 2. Term or temporary insurance. Here is a brief review of the two categories and the most of the common forms of life insurance products within them:
Cash Value/Permanent Insurance
Whole Life – Whole life is the first type of cash value life insurance that most people probably think of when they think about life insurance. Whole life death benefits, premiums and cash surrender values are typically fixed when you buy the policy, and cannot be changed later. This means that your premiums will never change, your death benefit is fixed as long as you continue to pay your premiums, and it will build up cash value inside the policy. Many whole life policies pay dividends on the cash value, and these are generally non-taxable to the policy owner at the time they are paid (in a participating policy). These policies can be set up to have premiums paid every year until you die, or only for a set number of years, or even just one time up front. Loans can be taken from the cash value by the policy owner.
Universal Life – Universal life (UL) has a fixed cost of insurance and any premiums paid into the policy over and above the cost of insurance build up cash value. The cash value that builds up inside the policy earns interest each month, which is tax-deferred to the policy owner. Interest can be earned at a fixed rate, or linked to one of the stock market indexes. Either way, your cash value is safe and will not go down due to the stock market crashing. Loans can be taken from the cash value by the policy owner, and they are taken tax-free. These policies can be designed with either a fixed death benefit, or an increasing death benefit.
Variable Universal Life– Variable universal life (VUL) is very similar to universal life, except that the cash value can be allocated to a variety of sub-accounts similar to mutual funds. This gives the policy owner the potential to participate in market returns, but also presents additional risk. Some VUL policies can be linked to a market index and have protection from downside losses, as well as limits on upside gains. These policies also allow for loans to be taken from the cash value.
Final Expense – Final Expense life insurance, also called burial insurance, is usually a kind of whole life insurance policy. Some of the differences with final expense insurance is that the policies usually have small face amounts, ranging from $5,000 – $30,000. They also generally have simplified underwriting requirements, meaning you don’t have to take a medical exam or a blood test. These policies can build up cash value but they are usually designed to keep premiums as low as possible.
Term Life Insurance– Term life is temporary insurance that will last for a limited number of years, chosen by the policy owner. Typically term insurance will last for 5, 10, 15, 20, or 30 years. The longer the term is, the more expensive the insurance premiums will be. Term insurance does not build up any cash value, it just offers pure protection from an early death. Most often term insurance is used by younger people who have more bills and obligations than they do money. Term insurance is a great way to protect a young family with children as it would offer a way to pay off the mortgage, fund college expenses, and provide an income stream for the surviving spouse. The reality is, most term policies never pay off because people outlive the term (that’s a good thing!) For this reason, you may want to consider buying Return of Premium Term insurance. This type of term insurance is a little more expensive, but if you’re still alive at the end of the term, you get most of your premiums back (75% is a common amount).
Mortgage Protection Insurance – Mortgage protection is a type of insurance used to pay off your mortgage if you die, become disabled, or terminally ill. This is a great way to protect your family from a large mortgage responsibility in the event of something catastrophic. Mortgage protection insurance can be either permanent or term insurance. It all depends on how you want to do it. You need to make sure you work with a very experienced and knowledgeable agent who can customize your insurance policy to what you want and need.
Most life insurance policies either include some extra Riders, or features, at no additional cost, or you can add on riders for an extra charge. Commonly included riders with no extra cost are some kind of an accelerated death benefit. This means that if certain conditions are met, you get your death benefit (or part of it) early (before you die). This would include situations like a terminal illness, a chronic illness, and nursing home confinement. This benefit would allow someone to have access to funds while still living for whatever they might need it for. Maybe they want to take a big trip with their family, or pay off medical bills, or whatever. If they’re confined to a nursing home, they could use it to pay for their care.