5 Things You Need to Know About Life Insurance

Choosing a life insurance policy can take shape as either a very simple or very complex process.

For example, you can buy a term policy as the most affordable (and most straightforward) form of life insurance; it lasts for a specific amount of time—often up to 30 years—and typically pays your designated beneficiary only in the event of your passing during the term.

Alternatively, permanent life insurance is an umbrella term for insurance policies that never expire. In addition to a death benefit, they often include a savings component and may come loaded with additional features as well: and are often more complicated and expensive than term policies as a result. The category of permanent life insurance boasts several options including whole life, universal life, variable life, and variable universal life insurance policies.

Regardless of the type of policy you choose (or may already own), let’s discuss five things you should know about them.

The death benefit is tax-free for the beneficiary

One of the most common reasons people buy a life insurance policy is for the death benefit—so policyholders can ensure their family members aren't adversely impacted from a financial perspective upon their death. In most cases, beneficiary life insurance payouts are tax-free (with no need to report them to the IRS).

Your money grows tax-deferred in a cash-value policy

Retirement is costly, and costs will only continue to increase as the years march on: especially when you consider steadily rising healthcare expenses and the declining buying power of Social Security. Add in the fact that many surprise expenses often crop up for retirees, and the need to supplement your retirement income can quickly become a necessity rather than a luxury.

Regardless of your reasons for needing additional income, a permanent life insurance policy is one way to supplement your retirement savings as these policies typically allow you to build or "accrue" cash value (funded by a portion of your premiums) in addition to your death benefit. You can think of a cash value insurance policy as an investment-like savings account that includes a death benefit; one advantage of this is that the cash value portion of your policy grows tax-deferred, meaning you pay only taxes when you withdraw funds or surrender the policy.

Receive accelerated benefits if you fall ill

One way to protect your loved ones in the event of an untimely (and serious) illness is to add an accelerated death benefit rider to your insurance policy. While this is most common with respect to permanent life insurance, some insurers also offer this practice for term policies—sometimes at no extra cost.

More specifically, an accelerated death benefit rider is a policy provision (sometimes referred to as “living benefits”) that enables you to receive benefits while you’re alive but deemed terminally, critically, or chronically ill. This can help offset financial stressors for you and your family. However, as with life insurance withdrawals, know that any benefits paid for these riders will in turn reduce your death benefit payout.

Among different types of accelerated death benefit riders, some of the most common include:

• A terminal illness rider that allows you to receive a portion of your life insurance death benefit if your documented life expectancy is two years (typically) or less (per a physician’s diagnosis)

• A critical illness rider that typically covers conditions such as cancer, coronary artery bypass, heart attack, and paralysis—among others—and often triggers when the insured is unable to perform at least two ADLs (activities of daily living) including bathing, continence, dressing, eating, toileting, and transferring (walking or moving oneself from a bed)

• A chronic illness rider that allows you to access benefits to mitigate costs associated with chronic conditions (as with critical illness, this rider triggers when the insured cannot perform at least two of the abovementioned ADLs)

For individuals who need assistance with two or more ADLs, long-term care riders are also available to help pay for related expenses. However, please know these are often the most expensive riders added to a policy.

That said, an LTC rider is sometimes especially beneficial for those who lack a standalone LTC insurance policy (most Americans, in fact) and when you consider that Medicare doesn’t cover most LTC out-of-pocket expenses. One big advantage an LTC rider has over a standalone LTC policy is that it still pays the death benefit even if you never use the care benefit—whereas standalone policies can feel like wasted money if you never file a claim.

You can use life insurance as part of an estate liquidity plan

Life insurance also shines through as an efficient strategy to transfer wealth, as death benefits paid are typically income-tax-free and possibly estate tax-free if structured correctly.

One example is when an estate includes illiquid assets—such as a family business—that must be passed on. If this applies to you and your heirs are not expected to become involved in the family business, a life insurance death benefit can play a significant role as an equalizing transfer of wealth.

Elsewhere, families hit with significant estate taxes or other estate settlement costs—such as medical expenses, funeral services, and legal fees—can use tax-free proceeds from a life insurance policy to offset these costs and spend this money as they wish.

A trust can assume ownership of life insurance

A trust is a legal document used in estate planning to transfer assets to beneficiaries after you pass away. While many types of trusts do exist, all fall within two categories: living and testamentary. Living trusts are available as either revocable or irrevocable options. The former is created while the trustor is still alive and can be adjusted during his or her lifetime given ongoing ownership of property or assets. On the other hand, the latter is not easily changed as trustors relinquish control of assets to the trust itself: which in turn seizes ownership.

Many estate planners often recommend that life insurance remain in an irrevocable trust as assets in this type of account aren’t considered personal property and are therefore not included when the IRS values your estate to determine if taxes are owed.

In sum: things you need to know about life insurance

When most people think of life insurance, they assume its sole purpose is to pay a designated beneficiary a lump sum of money upon the insured person's death. You now know, however, that these policies can truly help you accomplish so much more.

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Vision Retirement is an independent registered advisor (RIA) firm headquartered in Ridgewood, New Jersey. Launched in 2006 to better help people prepare for retirement and feel more confident in their decision-making, our firm’s mission is to provide clients with clarity and guidance so they can enjoy a comfortable and stress-free retirement. To schedule a no-obligation consultation with one of our financial advisors, please click here.

Disclosures:
This document is a summary only and is not intended to provide specific advice or recommendations for any individual or business. 

Variable Universal Life Insurance/Variable Life Insurance policies are subject to substantial fees and charges.  Policy values will fluctuate and are subject to market risk and to possible loss of principal.  Guarantees are based on the claims paying ability of the issuer.

Both loans and withdrawals from a permanent life insurance policy may be subject to penalties and fees and, along with any accrued loan interest, will reduce the policy’s account value and death benefit.  Withdrawals are taxed only to the extent that they exceed the policy owner’s cost basis in the policy and usually loans are free from current Federal taxation.  A policy loan could result in tax consequences if the policy lapses or is surrendered while a loan is outstanding.