Life Insurance: One Size Does Not Fit All
In its simplest form, life insurance helps protect your beneficiaries against
economic loss caused by premature death. The proceeds go to them free and clear – generally
exempt from federal income tax. However, there is much more to life insurance.
There are a variety of different types of life insurance, and each type has
its own unique features and benefits. With this product, one size doesn't fit
all, and, like tailoring a suit or fitting a golf club, finding the right fit
takes knowledge and analysis.
Most consumers have heard of term life insurance and permanent life insurance;
what most do not know is how many variations of each there are. Examples of
term life insurance include level premium term, yearly renewable term and decreasing
term. Permanent life insurance includes whole life, universal life, variable
life and variable universal life to name a few. A good understanding of each
life product will allow you to make an appropriate decision on what type or
types of life insurance might be most beneficial to you at each stage of your
life or your business' growth.
A Versatile Tool
Life insurance can be a versatile tool to address many needs within a broad
financial or business plan. Its many uses can include:
For you and your family:
- Providing your dependents with cash for expenses and debts and a replacement
- Conserving your estate and providing cash to pay estate taxes
- Enabling you to equalize inheritances among your family members
- Leaving a legacy to your favorite charities
- Creating a fund to supplement your retirement resources
- Helping to assure your children's college education is funded in the event
of your early death
For your business and your employees:
- Funding attractive benefit plans that encourage long-term employment (these
may include non-qualified Deferred Compensation plans, executive bonus plans,
split-dollar insurance plans that share the cost with the employee, and Supplemental
Employee Retirement Plans [SERPs]).
- Funding a plan to help ensure your business will continue after the death
of a principal.
Term Life Insurance
Term life insurance is the most basic type of life insurance, providing a
death benefit only if death occurs within the specified term of the policy.
There is usually no cash value or savings component to the contract and premiums
may be renewable at varying rates on a yearly (or longer) basis or may be level
for the length of the policy. Contracts are typically offered for a period
or term of five, 10, 15, 20 or 30 years, or on an annual renewable basis.
Generally, term life offers the most death benefit protection for the lowest
cost. It is often used for defined protection needs, when there is a limited
cash flow, or if temporary protection, for a known duration or a specific purpose,
requires a substantial amount of insurance coverage and costs must be kept
at a minimum. These circumstances might include covering: the term of a mortgage,
dependent children to a specific age or large, temporary business obligations,
Whole Life or Permanent Insurance
Whole life insurance is a form of permanent life insurance. The appeal of
whole life is twofold: it assures a minimum death benefit, no matter how long
you live, as long as premiums are paid and those premiums are fixed and certain
to remain the same for the life of the insured. What is more, the premiums
you pay contribute to building a guaranteed minimum cash value, which can be
used in several ways. It can be borrowed against or withdrawn. If you decide
to close out the policy, for whatever reason, you can take the accumulated
cash or use it to purchase other insurance protection. If left untouched, the
cash value increases each year until it "endows" or becomes payable to you.
Whole life insurance is a good choice if you are looking to accumulate savings
to create a "living benefit" and if you absolutely want to have life insurance
in effect at your death, no matter when that occurs – in 10, 20 or even
Universal Life Insurance
Another form of permanent life insurance is universal life. It usually costs
less, initially, and offers more flexibility than whole life but has fewer
guarantees. It allows you to determine the amount and timing of premium payments
within certain limits in contrast to whole life insurance, with its unchanging,
regular premium payments. In fact, if cash values are sufficient to cover premiums
in a universal life policy, you may actually skip premium payments, without
Universal life offers minimal investment risk, with a lower initial premium
and considerably more policy flexibility than whole life. It is especially
attractive in terms of cost for people whose life expectancy may be relatively
short because of advanced age or deteriorating health. It may also be a good
choice if the funds you have available for insurance vary significantly from
year to year, due to cash-flow constraints.
Variable Life Insurance
Variable life insurance is an innovative insurance product that combines
death benefit protection with investment opportunity. That means there is the
potential for growth in your policy's cash values, and possibly in the death
benefit, too. Variable universal life (VUL) is a viable option if you are willing
to assume investment risk in exchange for potentially higher growth. As your
personal or family estate grows, VUL's death benefit – if properly funded – may
keep pace with inflation or escalating estate settlement costs better than
that of whole life or universal life. In short, if you want the lowest potential
cost, or the most flexibility over the long term – and have the necessary
risk-tolerance – variable universal life may be the most suitable policy
What Type of Insurance and How Much?
Now that we have identified several types of life insurance products and
talked about how they are used, think about how to determine how much life
insurance coverage is needed and what life product or combination of life products
is most appropriate for someone's particular situation. We determine the type
of product by outlining goals and objectives and the amount of coverage by
completing what is commonly referred to as a "needs analysis".
First, a number of questions should be addressed: Is our life insurance coverage
going to be used for individual family planning or for business planning? How
much coverage is needed and for how long is the coverage needed? Are we looking
to build savings or just looking for pure protection? What funds are available
to be allocated to pay premiums for life insurance?
After these questions are addressed a needs analysis for life insurance should
be completed. A needs analysis is a calculation based on your personal financial
information and includes your family's needs to determine the appropriate amount
of life insurance. There are a number of important factors to consider when
determining how much life insurance protection you should have in force.
- Any immediate needs at the time of death such as final medical expenses,
burial costs and estate taxes
- Funds to pay off outstanding debts, such as a mortgage, credit cards, car
loans or any income taxes due
- Ongoing financial needs such as monthly bills and expenses, day care costs,
university tuitions and retirement income
Although life insurance can simply provide a death benefit to your beneficiaries
upon your passing, it can also be a complex financial instrument used to accomplish
diverse and multifaceted goals. Determining the most appropriate life product
and the most appropriate amount of life insurance for an individual takes considerable
thought, an outlining of goals and objectives and an analysis of the unique
features of each life insurance product currently available in the marketplace.
The appropriate life insurance product and design of coverage can help improve
your overall financial security, ensuring your family and/or your business
financial stability in case of your unexpected death.
Todd E. Binder, MBA, is an associate of FranklinMorris,
Coordinating Broker for the Bar Associations Insurance Agency, Inc. For more
information on the insurance benefits available to MSBA members, visit www.msba.org/departments/membership/baia/franklinmorris.pdf.