DEMYSTIFYING LIFE INSURANCE
Michael Tove PH.D., CEP, RFC
March 2015
When properly established and structured, Life Insurance can be one of the smartest financial
planning tools a person can own. It provides risk-free, non-taxable cash to help loved ones and/or
heirs get through financial challenges at a time of family hardship and grief. But, Life Insurance
policies can be extremely variable in type and cost for what is seemingly the same amount of
benefit and few lay people are sufficiently skilled to know the differences.
BASIC TYPES OF INSURANCE.
Term: This is coverage specific to a temporary insurable need. In other words, it is insurance for
a specified number of years after which the policy terminates. Term Insurance is inexpensive
because the insurance company is “betting” they will never pay the claim. If a person’s insurable
need is specific and finite (e.g., “Until I retire, then it doesn’t matter.”), Term Insurance is the
way to go. But if the insurable need is not precise, indefinite or permanent, it is the wrong
product type.
Whole Life (WL): Prior to 1987, Whole Life represented the opposite to term as “Permanent
Insurance.” In truth, no life insurance is absolutely “permanent” but prior to the late 1980’s few
people outlived their Whole Life policies. Whole Life works by including premium greater than
necessary to simply pay for the cost of insurance. The excess premium amounts are held as
“Cash Value” which grows by a pre-determined interest rate. If the actual return is greater, the
policy will pay “Dividends” that function to purchase additional insurance (called “Paid-up
Additions”). However, significant tax law changes in 1987 changed the attractiveness of Whole
Life and today it is most commonly affiliated with small “Final Expense” (burial) policies.
Universal Life (UL): Since the late 1980’s, UL’s overtook Whole Life as the preferred form of
permanent insurance. Today’s policies commonly offer guaranteed death benefit payments well
past age 100. The face amount (death benefit) is commonly much greater for the same premium
dollar as Whole Life. ULs do not offer dividends but the overall much higher face amounts more
than compensate.
Survivor UL (SUL): These policies simultaneously insurance two persons, most commonly
husband and wife and pay out only after the second death. Not only does this provide a larger
death benefit for the same premium dollar as single life ULs, is perfectly coordinates with estate
planning needs when issues of probate, inheritance tax and estate settlement are important.
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Increasing UL (IUL): These specialty policies grow the cash value AND death benefit amount.
While they generally start off less than traditional ULs, for a person living their average life
expectancy or longer, the total death benefit amount can be considerably larger when the time
comes. They can also be used for tax-advantaged cash accumulation as an income-planning
resource.
UPGRADING LIFE INSURANCE.
Many people with existing cash value policies can make them bigger and better at no cost. As
life expectancies increase, the theoretical cost of insurance goes down but insurance companies
do NOT revise their premium structure after policy issue. Therefore, even though a person is
older and maybe in less than perfect health, it is not uncommon to double or even triple the value
of a policy (death benefit amount) at NO cost (no additional premium).
REVISING INSURANCE NEEDS.
Sometimes people’s needs change. With that, existing coverage may become either unnecessary
or, conversely, insufficient. Either way, a periodic review of coverage and need is a
recommended exercise.
ESTATE PLANNING 101.
Few of us have comprehensive financial and estate plans handed to us. Planning is a process
which we all must undertake, starting with the basic premise that “It’s time to plan.”
Owning a life insurance policy simply because “we’re supposed to” is seldom a good idea but
when a policy is carefully identified as part of a larger plan, there is no substitute. Some of the
common uses for Life Insurance with a comprehensive Estate Plan are:
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Income security for a spouse, partner or dependent.
Protection from the cost of probate and inheritance tax.
Equitable estate settlement among heirs, especially when the estate includes a lot of illiquid
property such as real estate.
Special Needs considerations for heirs who may need extra help.
Securing a tax-free and risk-free retirement legacy for heirs, especially those who are much
younger than the insureds.
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