Column 35 Life Insurance

Surprise!  There is more to your insurance life than just the Affordable Care Act.  In fact life insurance can be an important tool to help guarantee financial security for individuals, businesses and charitable organizations. It is one of the most unique financial instruments available.

There are 3 basic parties to the contract:  Insured, owner & beneficiary.  Insured is the person(s) whose life is at risk.  Owner is the party who controls the contract: i.e. names beneficiary, can change the contract or borrow against it.  The beneficiary is the party that receives the proceeds in the event of the death of the insured. 

Most people are familiar with the simplest form of life insurance: Term.  Like the name describes, it's usually established for a fixed term or time period; for example 20 years or 30 years to coincide with a mortgage.  Premiums can be level throughout the term of the contract or maybe increasing at the risk of death increases.  There is no cash value accumulation so it's much like renting your life insurance.  The insured dies during the term, it pays.  If not, then the policy ends. It can be very inexpensive, especially when purchased at younger ages.

Permanent life insurance is a more complicated contract and has different hybrids.  Most common are Whole life, Universal Life and Variable life.  These contracts will typically have a higher initial premium but will also include cash accumulation features and non-forfeiture factors.  These contracts are designed to solve longer term problems.  For example, if you expect your need for life insurance will be present regardless of when you die, then permanent insurance makes good economic sense.

When asked "How much life insurance do I need"?, my reply is "What do you want it to do for you?"  If it's simply a case of income replacement for your family, we can determine how much income you need to replace and for what time period, then calculate the amount.  You may have other assets that can provide a portion of the cash needed.  These could be personal assets such as retirement plans, securities, cash or real property.  Or they could be government assets such as social security benefits that would be available to your beneficiary.

Life insurance can be the best tool to provide cash to keep a family in their own world at the death of the parent or breadwinner.  Cash is typically available within a few weeks of the date of death and with proper reinvestment can provide security for a family to keep their home, educate the children and essentially meet the goals and dreams that were in place before the death.

Life insurance is a unique instrument for the large estate owner as well.  When the estate is large enough that there will be an estate tax, it is much better to use the discounted dollars of a life insurance policy to pay those taxes. Through proper ownership the life insurance can be kept out of the estate and provide the liquidity need to pay the estate taxes for mere pennies on the dollar.  For example if one paid $200,000 over the life of a $1,000,000 life insurance policy, only 20 cents was paid for each dollar used to pay the taxes.

Of course, if there is a $1million estate tax liability there are other assets in the estate that could be sold to provide the cash.  But in that case it will cost at least $1 for every $1 liquidated, and probably more.  If real estate is used, there will be costs to sell or liquidate the property as well as the opportunity cost of selling what might be a valuable income or growth producing asset.  Again, ownership is very important.  If the insured has incidence of ownership, then the policy face amount is included in the estate and has merely inflated the estate.

Life insurance can be a valuable tool for charitable uses as well.  The policy that is simply gifted to a charity can provide a much larger overall gift to the charity while providing a current income tax deduction to the donor. More complicated structured gifts can incorporate life insurance to leverage the value of the donation to the charity as well.

One of my favorite comments is when someone says, "I don't believe in life insurance".  I explain that it is not a religion, just a unique and versatile financial tool.  In addition for those that buy just accident insurance, I caution that if you need life insurance you need it no matter how you die.  So buying accidental death only coverage is more like buying a lottery ticket.