Cona Elder Law


Life Insurance Options

When it comes to choosing a life insurance policy, you may feel dazed by your options. Here are the basic types and the pros and cons of each.

If you are interested in life insurance, any insurance salesperson will be delighted to explain the bewildering array of policies available to you. But unless you educate yourself first, it's all too easy to get mesmerized by insurance policy lingo and end up paying too much for a policy that may not meet your needs.

Term Insurance

Term insurance provides a preset amount of cash if you die while the policy is in force. For example, a five-year $130,000 term policy pays off if you die within five years -- and that's it. If you live beyond the end of the term, you get nothing (except, of course, the continued joys and sorrows of life itself). With term insurance, you pay only for life insurance coverage. The policy does not develop reserves.

Term insurance is the cheapest form of coverage over a limited number of years, especially when you're young. It is particularly suitable for younger parents who want substantial insurance coverage at low cost. Since the risk of dying in your 20s, 30s or 40s is quite low, the cost of term insurance during these years is as reasonable as life insurance prices get. Also, if you need insurance for only a short time, say to qualify for a business loan, term is your best bet. However, the older you are, the more expensive term insurance premiums become compared to the payoff value of the policy. This, of course, is understandable, as the older you are, the greater the chance you will die during the policy term.

Term policies offered by different companies have all sorts of differences, some fairly significant. For example, some policies are automatically renewable at the end of the term without a medical examination, often for higher premiums, and some are not. Some have premiums set for a period of years, but others guarantee a premium rate for only the first year. After that, the rate can go up. Some can also be converted from a term to whole life or "universal" policy during the term, again without needing to requalify.

But remember, with term insurance you never lock in the right to maintain the policy no matter how old you become. If you want to ensure that insurance will continue in force for your entire life, term isn't for you.

Permanent Insurance

Permanent insurance is much more expensive than term insurance. Why buy it? Because it can never be canceled as long as you pay the premiums, and because it's also an investment.

With a permanent policy, your premium payments for the first few (or more than a few) years cover more than the insurance company's cost of your risk of death. The excess money goes into a reserve account, which is invested by the insurance company. Unless the company is disastrously managed, these investments yield returns in the form of interest or dividends. A proportion of these are passed along to you. You can add these returns to your policy reserves or borrow against them, after a set time. And if you decide to end the policy, you can cash it in for the "surrender value."

Returns that accumulate are not taxable, unless the money is actually distributed to you. Certain partial withdrawals can even be made without paying tax. By contrast, the interest on bank accounts is subject to tax in the year it is paid, even if left untouched in the account.

However, although permanent insurance policies do function as an investment, maximizing your investment return is not the purpose of insurance. If that's what you want, you'd probably do better to buy cheaper term insurance and put the money you save in other tax-deferred investments.

Here are more details on several types of permanent life insurance.

Whole Life Insurance

Whole life (sometimes called "straight life") insurance provides a set dollar amount of coverage which can never be canceled, in exchange for fixed, uniform payments. Because the payments are the same throughout your life, in the early years of the policy, the premiums are high compared to your statistical risk of death. This is why reserves are built up. Assuming you live a long while after the policy was issued, your payments become low -- compared to your risk of death. In other words, during the first few years of a whole life policy, insurance companies take in substantially more money than they pay out.

Some of the surplus goes to pay the insurance agent's commission. Some of it becomes your cash reserve, which the company puts in fixed-income investments. After a set time, usually several years, you have the right to borrow against the cash reserve. You can also, of course, cancel the policy and receive its cash surrender value.

Whole life is generally undesirable for younger people with small children who can't afford the high premiums during the early years of the policy.

Universal Life Insurance

Universal life combines some of the desirable features of both term and whole life insurance, and offers other advantages. Over time, the net cost of universal usually is lower than whole life insurance. With universal life, you build up a cash reserve, as with whole life. But you can also vary the premium payments, amount of coverage, or both, from year to year. In contrast, whole life requires one set payment amount, which cannot be varied, for the life of the policy.

In addition, universal life policies normally provide you with more consumer information. For example, you are told how much of your premium goes towards company overhead expenses, reserves and policy proceed payments, and how much is retained for your savings. This information isn't usually provided with whole life policies. There can be other significant advantages to universal life; an insurance agent will be glad to explain them to you.

Variable Life Insurance

Variable life insurance refers to policies in which cash reserves are invested in securities, stocks, and bonds. In a sense, these policies combine an insurance feature with a mutual fund. That means your investment return is tied to the financial markets' performance.

Variable Universal Life Insurance

Variable universal life insurance is a type of whole life insurance that combines the premium payment and coverage flexibility of universal life insurance with the investment opportunity (and risk) of variable life insurance.

Single-Premium Life Insurance

With single-premium life insurance, you pay, up-front, all premiums due for the full duration of the policy. Normally, any policy with a savings feature can be purchased with a single premium. Obviously, this requires a large chunk of cash -- $5,000, $10,000 or often much more, depending on your age and the dollar amount of the policy. One reason to commit so much cash to buying an insurance policy is that it enables you to give the fully-paid-for policy to new owners, which can result in major estate tax savings.

Because there are no more payments to make, a gift of a single-premium policy doesn't involve risks that the new owners will fail to make payments and cause the policy to be canceled.

Survivorship Life Insurance

Survivorship life insurance (also called "second to die," or "joint," insurance) is a relatively new type of insurance. It provides a single policy that insures two lives, usually spouses. When the first spouse dies, no proceeds are paid. Instead, the policy remains in force and the surviving spouse must continue to pay premiums. The policy pays off only upon the death of the second spouse.

Why would any couple want such a policy? Mainly for use as part of an estate plan for wealthier couples who expect that substantial estate taxes will be assessed on the death of the second spouse.

None of this is of interest to people with small or moderate-sized estates.

This type of insurance may also be desirable when a major family asset is a valuable family business, or real estate interests -- assets that aren't liquid, and which the survivors may not want to sell. Or suppose two children inherit a family business, but one doesn't want to keep it going. The other could use her share of the insurance proceeds as an initial buy-out payment, so she could retain ownership of the business.

Finally, this kind of insurance may be desirable if one member of a couple is in less than good health, making other types of insurance extremely expensive. Because two lives are insured, premiums for survivorship life policies are relatively low compared to policies on one person's life. Therefore, if the other spouse is in reasonably good health, the couple can usually obtain survivorship life insurance.

Federal Taxes and Survivorship Life Insurance

The federal tax laws governing survivorship life insurance are somewhat ambiguous. Because this is a new and complex area, you need to check with a good estate planning lawyer who has current knowledge of the tax rulings on this type of policy. Also, discuss this issue with your insurance agent to ensure your survivorship policy will have the effect you intend. It may be best to have the policy owned by a life insurance trust. 

About the Author Cona Elder Law

Cona Elder Law is a full service law firm based in Melville, LI. Our firm concentrates in the areas of elder law, estate planning, estate administration and litigation, special needs planning and health care facility representation. We are proud to have been recognized for our innovative strategies, creative techniques and unparalleled negotiating skills unendingly driven toward our paramount objective - satisfying the needs of our clients.

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