Life Insurance As Part of Financial Planning

Why Buy Life Insurance?

People buy life insurance for one major reason: to protect income for the survivor(s) in case of the breadwinner’s untimely death. Insurance proceeds are a handy source of cash to pay the deceased’s debts, funeral expenses, and income or death taxes.

Upon death, policy benefits are paid directly to the beneficiary of the insured upon proof of death. The beneficiary gets the death benefit free of all taxes and, usually, the claims of creditors. Since the benefit is paid immediately, life insurance is a useful vehicle to raise cash under time pressure to pay outstanding bills such as medical costs, ongoing expenses such as day care or tuition, funeral expenses or income taxes. Your survivors may also need funds to help them readjust after your death in case they have to move or incur additional expenses to find work.

Do You Need Life Insurance?

If you have minor children or dependents who rely on you for financial assistance, you probably do. If you have no dependents, you probably do not need life insurance.

For active military personnel, the government offers SGLI, a term policy that has attractively priced payments. In the civilian world there are a variety of options, some of which utilize life insurance as a vehicle within a larger personal financial plan.

What Types of Life Insurance Are There?

There are several types of life insurance: term and permanent (including traditional whole, universal, variable, variable universal, single-premium and survivorship). All of these pay at least the amount of the policy upon death to the beneficiary named by the person insured.

Term insurance

Term insurance is the cheapest form of coverage over a limited number of years, especially when you’re young. A term policy provides coverage for a specified period of years (i.e. the “term”). It has no investment component. The policy, in and of itself, has no cash value, which is why it’s cheaper. Upon your death, the amount of policy coverage is simply and quickly paid to your beneficiary.

Term policies can be in any kind of annual increment, up to twenty years. They are renewable, often at a higher cost, but like any payment program without an equity component, you have no cash value in the end, other than the face amount of the policy.

As a financial planning consideration, you might purchase term life insurance and then invest the difference you would pay for higher cost permanent life insurance in other vehicles such as mutual funds, money market accounts, equities, etc. This, however, requires fiscal discipline on your part on an ongoing basis.

How Does Permanent Life Insurance Work As Part Of A Financial Plan?

With permanent life policies, you have two values. One is the policy’s face amount, i.e. the guaranteed dollar amount paid immediately upon death. The other is a cash value. Cash value is the amount available if you surrender a policy before its maturity or your death. The cash value is affected by your insurance company’s financial reserves and/or by investment earnings.

Viewed as an investment vehicle, a traditional whole life policy can be an attractive conservative investment. (If you are looking for dramatic returns on your investment, life insurance is not the proper vehicle.)

Whole life insurance is much more expensive than term insurance. Whole life insurance provides a set dollar amount of coverage that can never be cancelled, in exchange for fixed, uniform payments. Payments remain the same throughout your life and the premiums seem high in the early years compared to your statistical risk of death. Reserves are therefore accruing.The insurance company invests these reserves into conservative investment vehicles so that the entire policy is worth the face value plus the investment interest at the time of death.

Permanent insurance as an investment vehicle is designed to accrue over a long period. Therefore, if you surrender your policy in the early years, there may be little or no cash value.

In the whole life policy, the insurance company chooses where the investment portion of the premium dollar goes. If you want to make that decision, there is the variable life policy. The insured person selects from a number of options, which are potentially higher returning investments than an insurance company might make on your behalf. However, the options include mutual funds and other equities that comprise the stock market, which are more risky than the kinds of investments insurance companies would make. The choice is yours.

There is also universal life insurance. It offers many of the benefits of traditional whole life but it is more flexible. Premiums can vary from year to year (unlike whole, which are fixed). You can withdraw your cash value or borrow against it at any time. Unlike in whole life where you may also earn annual dividends, in universal life you earn interest at a fluctuating annual rate.

Even in you choose permanent life insurance, remember that life insurance should not be purchased mainly for investment purposes.

Life Insurance to Cover Debts

There are additional life insurance options for you concerning money management (as opposed to long-term financial planning). One is credit life insurance, which is offered to you by lending institutions when you take out a loan. The premium you pay covers the balance of the loan should you die. The cost is based on the size of the loan. If the policy owner/debtor dies, the insurance means that the loan is paid off in full and no debt passes on to your survivors.

Is Life Insurance Taxable?

The proceeds of a life insurance policy are not subject to probate unless you name your estate as the beneficiary of the policy. Life insurance need not be used to pay estate taxes, which are not due until nine months after death; there currently is no federal tax due anyway on any estate valued at less than one million dollars.

The policy payoff (i.e. proceeds or death benefit) is part of your private contract with the insurance company, and it should promptly go to whomever you direct (the beneficiary) with no court involvement (i.e. probate). Proceeds from a policy owned by the decedent to a named person as beneficiary are excluded from federal income tax, as well as state income or death taxes in most states.

Source: Omni Financial®