Tax Tips
Life Insurance: Know the Questions To Ask- April 2006
Richard Scrivanich - Partner
Should I purchase term insurance or permanent coverage? Who should my beneficiaries be? Does it matter who owns the policy: Will proceeds be included in my estate? If you’re in the market for life insurance, sooner or later you’ll need to think about these questions. Choosing the right type of life insurance and structuring it to meet your needs is a complex process, but here are some areas you will need to consider.
Do I even need life insurance?
Many people wrongly assume that everyone needs life insurance. If you have no dependents, or if you don’t generate a significant percentage of your family’s income, you may not need life insurance at all, or you may wish to maintain just enough to cover your final expenses. On the other hand, if your salary is critical to supporting your family, paying the mortgage, or sending your children to college, life insurance can help meet these financial obligations should you die prematurely.
Keep in mind that it is not necessarily only the family breadwinner who needs life insurance. Although a stay-at-home parent may not contribute cash income to the family, he or she provides important services, such as caring for the children and keeping up the home, which would be costly to replace.
As your life situation changes, you will want to reevaluate your life insurance needs. You may find that you need less or different coverage, perhaps for estate planning purposes rather than income protection, since life insurance can also be earmarked for paying estate tax settlement costs, shifting wealth to the next generation, or benefiting favorite charities.
How much insurance do I need?
The right amount of coverage depends on your personal situation, your current and anticipated financial resources, and your estate planning goals and needs. Other factors include your age, health, number of dependents, your debt level, and your lifestyle.
As a first step, you should take inventory of all your financial resources and estimate how much your family would need to maintain its lifestyle without your income. Remember that if your assets are tied up in real estate or in a business that would have to be sold for your family to survive financially, you may need more insurance than if you had significant liquid assets.
Term or whole life?
There are two basic types of life insurance: term insurance and permanent life insurance. Term insurance covers you for a specific period of time. If you die during the term of the policy, the proceeds of your policy are paid to your beneficiary. Permanent life insurance, or cash value insurance as it is sometimes called, provides a savings or investment component in addition to the death benefit.
Term insurance is the most basic and often the least expensive type of coverage. You can buy term insurance for one year at a time, or for a specific period such as 5 to 10 years. If you die during the term, the proceeds of your policy are paid to your beneficiary(s). The cost of term insurance gradually rises as you age.
Permanent insurance policies, such as whole life, universal life, and variable life, combine a death benefit with a savings feature, since the policy builds cash value. Premiums can be several times higher than you would pay for the same amount of term insurance, especially in early years of the policy, since, in addition to a death benefit, part of your premiums are invested and build up a cash value.
While the primary reason for any life insurance purchase should be income protection for your family, permanent insurance policies provide long-term and investment-like features that some people find appealing. However, if you are looking for pure return on capital, other investments usually provide better results.
Who should I name as beneficiaries?
The naming of beneficiaries can be a surprisingly complex decision. You will need to consider not only which family members the proceeds are intended to benefit, but their ages and financial acumen as well. For example, if you have minor children, you will need to consider who would be in the best position to manage the proceeds as you wish. It may be advisable to use trusts in certain situations. You will even need to consider your marital status – or even the health of a marriage – when making these types of decisions.
Who should own the policy?
The owner of a policy is not necessarily the person insured by the policy, and it is critical to arrange for the proper ownership. For example, even if you name beneficiaries other than your estate, life insurance will be includable in (and potentially taxable to) your estate unless you have transferred “all incidents of ownership” of the policy either to another person or an entity such as a trust.
How do I shop for life insurance?
You should begin to look at insurance companies and polices only after you’ve sought professional advice regarding the tax, financial, and estate planning ramifications of the various choices.
Then, if you need only term insurance, you may be able to shop around on your own for the most coverage for the best price, keeping in mind that prices vary widely for the same coverage.
If your needs are more complex, you will likely need to work with an insurance agent, who may be an independent agent working with many insurers, or an exclusive agent who sells policies for just one company. In either case, you will need to know if the agent you choose has the right licenses to sell the policy that best address your needs.
A life insurance policy is only as good as the company behind it. Rating agencies, such as A.M. Best and Moody’s Investors Service, grade companies based on their financial stability, the timeliness with which claims are paid, and the quality of customer service.
What next?
Your insurance decision will depend on your needs, resources, and goals. Your choices will also depend on risk factors, including your health, your age, your family’s medical history, and the type and amount of insurance you are looking to purchase.
If you have any questions regarding life insurance or any other tax matter, please feel free to give me a call at (562) 698-9891.
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