Life Insurance Protects the Ones You Love & Enriches Your Estate
II. Permanent Life Insurance
Permanent life insurance is life insurance that remains active until the policy matures, unless the owner fails to pay the premiums when due. A permanent insurance policy accumulates a cash value. This characteristic:
The four basic types of permanent insurance are 1) whole life, 2) universal life, 3) limited-pay and 4) endowment.
1. Whole Life Insurance
The simplest (traditional) form of permanent life insurance is whole life. Whole life insurance provides lifetime death benefit coverage for a level premium in most cases. The cash value of a whole life policy increases over time based on “excess” premiums plus earnings. Cash value is calculated from insurance company charts based on the age of the insured and the number of years that the policy has been in effect.
This cash value can be accessed at any time until the insurer’s death through “policy loans” which are received income tax free. If there are any unpaid loans upon death, the insurer subtracts the loan amount from the death benefit and pays the remainder to the beneficiary named in the policy.
The advantages of whole life insurance are:
The disadvantages of whole life are inflexibility of premiums and the fact that the internal rate of return in the policy may not be competitive with other savings alternatives.
2. Universal Life Insurance
Universal life insurance (UL) is a relatively new insurance product that combines permanent insurance coverage with greater flexibility in premium payment, along with the potential for greater growth of cash value.
With universal life insurance, the cash value grows through the addition of insurance premium payments and investment income. The policy’s cash value decreases as the insurance company subtracts (from the cash value) the cost of insurance, cost of insurance riders and sales/administrative expense.
Investment income is determined by the type of policy:
Unlike whole life, universal life has a flexible death benefit (unless it is a guaranteed death benefit policy). Flexible death benefit means the death benefit can change based on investment growth, or the policy owner’s decision to increase (with new underwriting) or decrease the death benefit.
The flexible premium feature allows:
Upon the death of the insured, the policy pays the death benefit exclusive of the cash value. The surrender value of the policy is the amount of cash value payable to the policy owner after applicable surrender charges, if any.
3. Limited-Pay Life Insurance
Limited-Pay life insurance is a type of permanent insurance in which all the premiums are paid over a specified period (e.g., 10-20 years) after which no additional premiums are due. At policy maturity you have paid-up insurance for the rest of your life.
This policy has a death benefit that is guaranteed to stay level for as long as you own it even if you choose to keep it until age 100. The face amount is usually paid out income tax free to the beneficiary of your choice. It can be paid in one lump sum or in the form of a monthly income.
Endowments are permanent insurance policies in which the cumulative cash value of the policy equals the death benefit at a certain age (the endowment age). You choose how much you want to save each month and when you want the policy to mature. These policies provide a risk-free, guaranteed return on a guaranteed date, which make them appealing as college savings plans.
If you should die before the policy matures, your child will receive the payout as your death benefit, still providing them the anticipated money for college. What's more, the payout isn't counted against your child's financial aid eligibility.
Endowments are considerably more expensive (in terms of annual premiums) than either whole life or universal life because the premium paying period is shortened and the maturity date is earlier.
Based on the above, I’m sure that you see several areas where life insurance can play a significant role in your retirement and estate plans. Below is a table showing examples of these. Keep in mind that these represent only a few of the many ways of utilizing life insurance, and many other opportunities are possible.
As you relate these life insurance alternatives to your specific situation, keep in mind that one of the major advantages of life insurance is that death benefits are generally excluded from income tax to the beneficiary. However, they are included as part of the estate of the deceased if the deceased was the owner of the policy at the time of death.
This inclusion as part of the estate may subject the benefit paid to estate taxes both at the federal and state levels. Estate inclusion can be avoided if the owner of the life insurance policy is someone other than the deceased, however; this assignment must have occurred more than three years prior to the date of death, or the IRS will still consider the deceased as the policy owner for estate tax purposes.