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Part 1 of a 3 Part Overview on Providing For your Families Financial Needs
No one likes to think about their own mortality, but if providing for the financial well-being of loved ones when you aren’t there anymore is important to you, it may be a good idea to start. Like paying taxes, death of course is an absolute certainty. According to the US Census Bureau, about 2.5 million people die every year in the United States. Heart disease, cancer, & chronic respiratory disease are the three leading causes according to the CDC. One common denominator in many deaths is the failure to prepare financial provisions for loved ones before the Grim Reaper shows up. Ed Hineman of the Hineman Group did some number crunching and determined that “out of the 6,850 people that die every day, 3,292 die without any life insurance at all. Another 1,445 die without adequate life insurance. So, 48% of people who die every day leave no life insurance benefits behind and another 21% don’t leave enough.”
Life insurance, although a sensible tool to resource your loved ones’ financial security, shouldn’t be your first choice. Your own savings should. Why pay money to an insurance company if you don’t have to? Self-insure instead, if you can. For example, if you have a million or two tucked away in a bank or brokerage account and believe that amount is sufficient to maintain the pre-determined standard of living you have set for your family, then you’re golden. If you have about the same value in real property, like real-estate, or a business that could be easily liquidated or converted into cash at your death, then great, you’re there; go solve another problem. But, if you don’t have those kinds of financial resources just hanging around, life insurance may be a viable option. Life insurance essentially transfers the financial risk associated with premature death from your loved ones to an insurance company, evening out the burden on them after the main breadwinner’s death. The first step is to determine your loved ones financial need, that is your family’s desired standard of living minus your income including the need to satisfy any obligations to employers and creditors from arrangements put in place before death. If you find you don’t have enough savings or liquid assets, life insurance coverage may be the ticket. So, the next step would be to decide on what type of life insurance to secure. You have essentially two options: Term Life Insurance, and Cash-Value Life Insurance.
Term Life Insurance, the simplest of all life insurance contracts available in the market-place today offers pure protection in exchange for a fixed relatively low premium. These policies provide beneficiaries a certain amount of money at the insured’s death, simple as that. Term insurance gives the newly insured the best bang for their buck. It’s designed to last for 5 to 40 years, your premium is fixed for the entire period, and you can terminate the contract at any time without penalty. With Term Life Insurance, you’re essentially renting coverage for a certain period of time. A word of caution however, if you stop paying premiums and the policy cancels, you walk away with nothing.
Cash Value Life Insurance is a little different, it includes a savings & investment component in addition to a death benefit. Your premiums are usually higher than term. Cash-value life insurance addresses the complex desires of people looking for more than “payoff at death” protection from their policies, such as lifelong coverage, more flexible premiums, or the ability to borrow or withdraw money from the insurance fund. In order to make any of these feasible, insurance companies that offer cash-value plans take higher premiums than term and invest the excess money in investments meant to grow over time.¹
There are basically three types of cash-value plans. Whole-Life, Guarantee Universal Life, and Variable Life.
Also called “permanent” insurance, whole-life insurance is the original lifetime policy. It uses a level premium throughout the insured’s life. Whole-life Insurance is a life insurance policy which is guaranteed to remain in force for the insured’s entire lifetime, provided required premiums are paid in full. Premiums are fixed and usually do not increase with age.²
Guarantee Universal life (GUL) insurance policies provide a death benefit as well as the opportunity to build policy cash value. This coverage is different from whole life insurance in that within policy limits, you can vary the amount and timing of your premiums. Some contracts even allow you to increase or decrease your death benefit. As a policy owner, you have more flexibility with GUL than with whole life, but you assume additional risk. GUL policies usually have fewer guarantees than whole life coverage, so you must carefully manage premium payments and any distributions taken to help ensure your policy will stay in-force. This type of life insurance policy usually offers a built-in no lapse guarantee that can last for the lifetime of the insureds life or for a shorter period selected by the policy owner.” ³ We are not big fans of this contract. It seems it’s a better deal for the carrier than the client in many cases for a whole host of reasons.
Created to make up for inflation’s effect on your purchasing power, variable Life Insurance has been somewhat popular in the last two decades or so. In these policy contracts, the insured gets to decide where to invest the policy’s cash value from a menu of investment options offered by the carrier. We would not recommend these type policies either as the fees are inordinately high. If they are a good deal at all, they are better for very high tax bracket individuals that do not have time to attend to their investments.
Term insurance allows those insured to afford more death benefit because the premiums are much lower than cash value insurance plans. It’s also far simpler and much more affordable than cash-value policies.
Cash-value policies get favorable tax treatment, are relatively flexible, and can benefit the insured while still alive. They are more suitable for those who need permanent coverage and the ability to borrow against their policy. Cash-value policies also are an option for those who need the discipline of forced savings, don’t have a solid plan for retirement, and want lifetime coverage that does not expire.
We favor term because it’s just a better deal for the policy holder in most cases.
As always, we are here to help you any way we can. Please don’t hesitate to call or email if you need us.
The Deerfield Team
1.Vaughan, Therese M. (2013-10-28). Fundamentals of Risk and Insurance, 11th Edition. Wiley. Kindle Edition. (224-239).
2.Wikipedia.org – Whole Life Insurance
3.Geneworth.com – Life Insurance Types and Options