Originally published by Raymond James.
Protecting your loved ones
Marriage. A house. Kids. All of a sudden, life insurance seems important, necessary. Who will take care of them if something happens to you? Will they have what they need?
A life insurance policy helps your loved ones maintain their lifestyle should the unthinkable happen – allowing them an income stream and/or the ability to pay off debts, cover funeral costs, tuition and unforeseen expenses. So you talk to your financial advisor and an insurance expert and discover that a term life insurance policy can help you replace lost income, a need that exists at least until your children are independent or your mortgage is paid off.
When deciding your coverage amount, consider everything that will need to be covered, including the work of a stay-at-home parent whose valuable contributions aren’t tied to a paycheck as well as the intangibles that make life work. Who will care for the children? Cook? Clean? Maintain your home and yard? Be sure each adult is insured for the full amount a surviving spouse will need to keep the household functioning smoothly. Do you have a dependent with special needs? Life insurance may offer a way to provide a comfortable future for him or her.
Also consider any existing debt. Beyond a mortgage, maybe you secured a loan to start a business – a life insurance benefit could help resolve that debt. Finally, think about future obligations – perhaps a child’s college education – that could be costly for the surviving spouse. Your financial advisor can help you approximate what it takes to keep your quality of life up to your family’s standards now and in the future, and insure it accordingly.
Creating a cash cushion
A permanent policy – namely whole life, universal life or an indexed universal life policy – can offer a cash-value component for those looking to use their insurance policy as a cash cushion to fund unforeseen circumstances or pay for long-term health needs. It’s possible to “overfund” these accounts to accumulate cash value, allowing the funds to grow tax-free and still be accessed later. It acts much like a savings account, backed by the insurance company. Owners can even borrow against the value of the policy, and proceeds are tax-free. Gains can be withdrawn from the contract on a first-in, first-out basis that would also be tax-free – one of the more distinct advantages of life insurance.
Indexed policies may be a good option for the conservative investor looking for downside protection with additional upside potential. Such a policy isn’t likely to beat market returns and can be expensive compared to term policies, but if you’ve maxed out your contributions to other tax-deferred savings vehicles, it might be something to consider. Discuss the advantages and drawbacks with an advisor who is familiar with your specific financial situation.
Say your only daughter loves the lakeside cabin and visits it often. Your son, not so much. If you’re looking to keep things equitable, you can consider leaving the home to her and making your son the beneficiary on a life insurance policy of equal value. Life insurance can be a great equalizer when it comes to bequeathing illiquid assets like a business or property. Discuss your options with your insurance broker, estate attorney and your advisor to help ensure you’ve covered the necessary bases.
Decoding your policy
Provides a set amount of coverage for a set amount of time, or term, at a fixed rate of payments, often with more affordable premiums compared to permanent life insurance. The policy pays out if the owner passes away during the term. After the term expires, coverage can continue; however, the premiums will increase, often significantly. This might make sense for a family with young children, who’ll let the policy lapse after the parents have saved enough to provide for the family if the unexpected happens or after the children become self-sufficient. Some term policies can be converted to permanent life policies.
Permanent life insurance
These policies can be both more complex and more flexible. They guarantee a payment to the beneficiary after the insured’s death, as long as the policy doesn’t lapse. Permanent policies have an investment future that can provide a cash value and can be complemented by a variety of riders, including long-term care options. A family with a lifelong dependent, or one that wants to guarantee a certain amount of inheritance, might choose a permanent life insurance policy.
In the case of whole life insurance, the cash buildup comes from your premiums. You pay fixed premiums and guarantee a death benefit for your heirs. These policies typically have a guaranteed cash component that grows at a fixed rate. Whole life policies that pay dividends should be periodically reviewed in various market conditions.
Universal life insurance goes a step further, linking adjustable premiums to a fixed general account or, in the case of variable universal life insurance, to investment subaccounts. The cash component fluctuates with current interest rates. They may also offer a guaranteed death benefit.
- A general universal life policy is tied to the fixed “bond like” general account of the insurance company. An indexed universal life policy is tied to a specific market index or low-interest-paying account.
- Variable universal life policies have investment accounts that fluctuate with the market – greater risk, potentially greater growth.
Life insurance trusts
Without life insurance, estates worth more than the lifetime exemption may be subject to sizeable federal and state estate taxes, leaving the heirs with a substantially reduced inheritance. Conversely, affluent families can purchase trust-owned life insurance equal to their projected estate-tax liabilities. While the IRS will still take its cut, the life insurance benefit would pass both income- and estate-tax-free, increasing the overall inheritance without further increasing taxes.
These policies have exclusions and/or limitations. The cost and availability of life insurance depend on factors such as age, health and the type and amount of insurance purchased. As with most financial decisions, there are expenses associated with the purchase of life insurance. Policies commonly have mortality and expense charges. In addition if a policy is surrendered prematurely, there may be surrender charges and income tax implications. Guarantees are based on the claims paying ability of the insurance company. Raymond James financial advisors do not render advice on tax or legal matters. You should discuss any tax or legal matters with the appropriate professional.