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A. Overview

A. Overview.

Most people recognize one need for insurance: Income protection for the family in case of the breadwinner’s untimely death. But many people are unfamiliar with the usefulness of life insurance in facilitating the tax-efficient transfer of family wealth to the next generation. Although this is not an insurance course, a few introductory observations are in order, for those unfamiliar with this subject

Unfortunately, it is difficult to give much (good) general advice about insurance. First, it is necessary to identify if and why you need life insurance to begin with, and how much coverage, if any, to buy. Next comes determining the type of life insurance that best suits your particular financial circumstances, which include, but are not limited to the original need for insurance protection.

The basic varieties of life insurance are permanent, also called whole life, which includes an investment component, and term life, without one. At the time of purchase, a whole life policy represents the insurance company’s promise to provide coverage for the entire life of the insured person, as long as premiums are paid. A term policy, in contrast, provides coverage for a specified period of years – the policy “term.” (Whether, and at what cost, an expired term policy can be renewed for an additional period of coverage, is another matter entirely.)

Within each variety – term and whole life – there are many options and features that should be considered, and it can be a complicated process to sort through the choices available. (This is particularly true with whole life, due in part to the decisions that must be made regarding the investment portion of the premium dollar.) Once you have determined what you need, it is wise to do research and crunch numbers to find the best deal, from among those companies you deem sufficiently sound and reliable.

None of this is rocket science. It is simply a matter of spending some time educating yourself and going through a number of steps. There are plenty of resources on the Internet to help. Obviously, a trusted financial planner – preferably one without an iron in the fire – can be an immense aid in this process, but expert help is not essential.

Viewed strictly as an investment, a whole life policy from a quality company can compare favorably with other conservative vehicles, particularly due to the tax-deferred growth of the policy cash value. Term insurance has no cash value, so it is generally cheaper, at least at a younger age. If personal cash-flow permits, the money saved on term premiums, compared to the whole life alternative, is available for investment by the insured person on his/her own.

Number crunching to evaluate a traditional whole life policy can only be done with information obtained from the insurance company. It is not enough, however, to find an insurance agent you personally trust. It is not he/she, but the company that prepares the policy illustration you are shown. Question the assumptions made in the policy’s projected growth in value (for traditional whole life). If the company is investing your premium dollars conservatively – as it should – do not expect to see eye-popping returns. Be suspicious if that is what appears in the illustration.

An alternative to the traditional whole life policy is the variable life policy – in which the investment component and return of the policy (not the insured person!) varies. This is because the insured – not the insurance company – takes responsibility for selecting where the investment portion of the premium dollar goes. He/she selects from a number of options, including many similar to the mutual funds that most investors are familiar with. These are potentially much higher returning investments than an insurance company would make on its own. The stock market, however, is also more volatile and risky than the kinds of investments insurance companies are supposed to make. There is no “right” or “wrong” answer or conclusion to be drawn from these observations. The life insurance buyer simply needs to be aware of the complete picture.
Life insurance (all kinds) is not subject to probate proceedings, as long as the payoff is to a named person. Policy benefits are paid directly to this beneficiary upon proof of death. He gets the death benefit free of all taxes and (almost always) the claims of creditors. But if the policy is payable to the estate instead, the proceeds are just like any other asset of the estate, and are subject to creditors of the decedent.

BEWARE ! Most people know that life insurance death benefits are received income tax free by the beneficiary. But regardless of who is named as beneficiary, if the policy is owned by the decedent – as opposed to ownership by a spouse, child, Trust, etc. – the proceeds are included in his/her estate for federal estate tax purposes. This tax is only important for estates totaling $1 million (in 2003, $1.5 million in 2004 – See “Tax Issues”), but life insurance death benefits are often not considered, and push many people over the limit. Ownership of the policy by an irrevocable Trust may then be advisable to keep the proceeds out of the taxable estate.

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