Why Do People Buy Life Insurance?
The most obvious need, if you have children, you would purchase life insurance that would take care of their needs at least until they are old enough to take care of themselves. I cover the specific amount needed in another article.
The level of protection reduces over time simply because every year, your children are closer to the point where, hopefully, they no longer need your help. Additionally, if your goal is to help your spouse pay down or pay off your mortgage, the mortgage balance reduces over time.
Estate planning is one of the more common reasons older customers purchase life insurance. Upon death, a sizable estate could be subject to tens of thousands of dollars in probate fees, and up to millions of dollars in death taxes imposed at both the Federal and State levels. I worked with a client awhile back when the death tax exemption was only $1 million. He had 3 daughters, and three homes worth about $1 million each. The goal as to leave one home to each daughter upon his death. But, death taxes would probably be around $1 million in this case, forcing the daughters to sell one of the properties just to cover the tax. The easiest answer was to simply buy a $1 million whole life insurance policy to cover the tax. When the death tax changed to over $5 million, he simply changed to beneficiary of the policy to his grandkids.
I like the idea of using life insurance as an estate planning tool, less to cover probate and taxes, and more as an efficient way to leave a legacy. Life insurance is leveraged. Based on a recent quote, a 65 year old male can purchase a $100,000 life insurance policy for $2,514 in annual premium, guaranteed for life. With the alternative being to invest the $2,514 a year, if this individual dies at age 75, he would need to receive an annualized rate of return on his investment portfolio of 20.5% per year to reach $100,000. Assuming investment profits are subject to a tax rate of 25% on withdrawals, the investor would need a rate of return of 24% to equal the tax free benefit of the life insurance.
Of course, the longer the insured lives, the less dramatic the difference it. At a death age of 90, the rate of return needed to equal the life insurance proceeds would be 3%, or 3.8% assume of 25% tax on the profits.
Business Continuance & Buyout
When partners go into business together, one of the most important agreements they should come up with is to define what happens upon one of the partner’s death. At its most basic level, business continuance insurance is insuring each partner’s life, with the remaining partners as beneficiaries. It covers the expenses that the partnership would incur in either replacing the partner, or restricting the business.
With many business owners, though, much of their assets are tied up in the business, so a buyout option using life insurance proceeds would be necessary. The deceased ownership share would transfer to his or her spouse or children and the remining partners may just want to use the life insurance proceeds to buy them out rather than continuing with them as part owners.
Cash Growth & Investment
We’re not debating the merits of the concept here, but many investors purchase variable whole life or universal life insurance policies for the purpose of investment. These policies, if structured correctly, can accumulate significant cash values. The benefit over other more traditional investments such as mutual funds is that the growth is completely tax free. This can be attractive to investors who are already maxing out contributions to their Roth IRAs.
The down side of cash value policies is that there are significant fees associated that can have a dramatic impact of the bottom line investment performance.
Living Needs Benefits
A growing trend in life insurance is the idea of tacking on riders or benefits to policies that give the insured access to the death benefit value before death. For very little in additional cost to the premium payor, the insured can receive early access to benefits for diagnosis of terminal illness, diagnosis of major illness, and most importantly, the need to pay for assisted living needs or nursing home.
I want to address the assisted living benefit specifically because I think this can be a huge advantage to older insureds who are looking at purchase long term care insurance. The negatives of purchasing long term care through a life insurance policy are that you need to take a physical, and even if you are in good health, the premiums are costly compared to traditional long term care policies. The benefits, though, include.
- Fixed premiums: Most traditional long term care insurance policies charge policy holders a premium based on real claims. If claims are higher than expected, expect your premiums to increase. With a well designed life insurance policy, your premiums will not go up in the future.
- Indemnity vs. reimbursement: Many life insurance based long term care riders are indemnity policies, meaning as long as the insured meets certain pre-determined requirements, payment is made as a monthly cash benefit to be used however the insured sees fit. Most long term care insurance policies are reimbursement – payment is made directly to the facility providing services.
- Return of premium: If you pay premiums into a long term care policy, and you never need the benefit, you most likely never get your money back. Return of premium policies are very rare and expensive. With a life insurance policy, if you don’t use the long term care benefit, we know that eventually you are going to die. Upon death, your heirs will at least get the death benefit, so you know you will eventually get something for all those premium payment you made.