Purpose in the design
Life insurance can be a very important piece of financial planning and protection. There are many different purposes for life insurance that provide benefits for juveniles, buy-sell, business planning, loan protection, income protection, charitable giving, retirement planning, and legacy planning. Cornerstone will provide analysis and education to see what would serve a client’s needs and enhance their goals. This is accomplished through an abundant amount of data gathering and plan design.
Life insurance can be a powerful asset that makes the rest of a client’s investments work better. If carefully designed, policies can be a good enhancement and add an alternative asset class.
Types of life insurance:
Term life is the cheapest type of policy and usually comes in different guaranteed premium periods where the price is frozen eg. 5yr, 10yr, 20yr or 30yr terms. The longer the guaranteed period, the more expensive the policy. Once the term is over the policy either expires, increases dramatically or some can be converted to a permanent policy. The vast majority (over 95%) of term policies will expire or terminate before the policy holder does. This is due to policy terminations, loss of company coverage due to job loss, or economic circumstances. If a policy holder gets what they want (live longer than the term of their policy) they may lose the death benefit protection in retirement years.
Universal policies come in many forms. All have a cash accumulation component that is a function of regular interest (universal life), an index crediting that credits the account based on a determined calculation of market performance (indexed universal life), or a crediting of the account based on direct participation in the market typically through ‘clone mutual funds’ (variable universal life). These are almost always set up on an annual renewable term chassis. This is the cheapest form of life insurance (in the beginning). This allows less of a payment to go to the cost of insurance (in the beginning) and more to go to the cash account. Payments can vary and allow for the policy holder to pay in more to grow the investment portion of the policy. As time goes on the annual renewable term costs can increase, and this can cause the policy to erode the cash value to keep the policy active. Cash value can usually be used throughout one’s life for many benefits including other investments. The money can be paid back and then used again creating a personal bank. It is important to know the design and structure of these polices. If designed well, they can possibly serve a client well for many years, but if not funded properly they can end up expiring prematurely.
Whole life is designed to last your whole life. It costs more because of this, but also gives the best chance of guarantees. Most policies pay a guaranteed interest rate and have the potential to pay dividends. Mutual life insurance companies serve the policy holders versus stock companies that serve the stockholders. Dividends are not guaranteed, so it’s important to partner with a company that has a good track record for paying dividends to its policy holders. As cash value accumulates, the money can be accessed and used in many ways: surrender of the policy, cash withdrawal, or by taking a loan against the policy. When a loan is taken, the insurance company literally writes a separate loan and uses the cash value as collateral. The interest is an expense that is kept by the carrier, but this allows the policy holder to access the principal AND accumulation tax free. This also allows the cash to stay in the policy, gaining uninterrupted compounding interest. Even if the loan is outstanding, the insurance company will add money to the cash value based upon the amount in the cash value regardless of the outstanding loan. Some policies will also pay a dividend regardless of an outstanding loan, this is called a non-direct recognition contract. Direct recognition contracts can reduce the dividend based on the outstanding loan amount. When a loan is paid back, the policy holder has access to the money again for investments, real-estate, debt consolidation, or personal expenses. This ‘bank on yourself’ concept allows for flexibility and efficiency while growing wealth. If a loan is not paid off before the policy holder passes away, the outstanding loan and interest reduces the death benefit.
In retirement, the whole life cash value can be accessed through tax-free loans. The death benefit however is what allows people to spend their retirement accounts and investments more freely. This happens because the death benefit gives the policy holder the freedom to send their wealth or bless charities with their wealth while knowing that the death benefit will be left for their heirs often tax free.