Benjamin Franklin once famously opined that nothing in the world could be certain but death and taxes. But when it comes to estate planning, how can you separate the certainty of the former from the burden of the latter? Permanent life insurance is something to consider.
Despite the fact that few individuals want to contemplate death, life insurance can be a critical part of estate planning for most individuals in a way that other investment and insurance products are not.
The nature of insurance is that you pay into something you hope you don’t need but provides a safety net in the event of an unforeseen circumstance. Though you’d never own an automobile or home without insuring them, a successful journey with car or homeowners insurance might mean that you never use or benefit from it. But life insurance is different in that we’ll all experience a qualifying event, and some policies can accrue a cash value that can be borrowed against or withdrawn during our lifetimes.
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Why permanent life insurance?
Life insurance is most often bucketed into two categories: term and permanent. Term life insurance provides the policy’s beneficiary with a death benefit if the insured dies during the policy period — e.g. 10, 15 or 20 years. Once that term is up, the coverage has to be renewed, by providing evidence of insurability, to keep any benefit. However, some term policies include a conversion provision that allows the policy owner to convert the term policy to a permanent policy during a specified period of time (i.e, up to age 65) without evidence of insurability.
Permanent life insurance never expires, as long as you pay the premium. Both types of insurance can be appropriate for different financial situations or life stages, but when considering insurance’s role within estate planning, permanent is the most pertinent.
Consider these advantages of permanent life insurance:
- High benefit-to-premium value in early policy years
- Known and predictable death benefit
- Benefits are paid in cash
- Cash value grows tax-deferred
- Benefits may not be subject to income or estate taxes
- Low risk of carrier default
Life insurance, like most other investments, provides the most benefit when you start it early. Unlike other investments, though — where the principal benefit to early investing is the power of compounding — life insurance investors benefit because “younger and healthier” means better policy eligibility and premiums. It also means that in the unfortunate instance that death benefits need to be paid in the early years of the policy, the benefit will far outweigh any premiums that have been paid.
Those benefits are unique as well because they are made available in cash to beneficiaries, which can help to settle outstanding financial obligations or death expenses. Guaranteed cash benefits can extend beyond the immediate financial needs of estate settlement or inheritances, though, and prevent a beneficiary from being forced to sell a business, real estate or other interest-bearing investments to cover living expenses. Setting beneficiaries can also ease concerns about equitable treatment among heirs when it comes to the distribution of assets.
How your beneficiaries use a life insurance benefit is up to them, but how they choose to receive it will determine if or how they are taxed. Life insurance benefits are generally available as a lump sum, timed installments or even as annuity payments. For most, choosing a lump-sum payment means avoiding income or estate taxes on the benefit, while receiving benefits over time could mean taxes on additional interest earned. A financial adviser can help assess what type of payout option would be most advantageous for you or your beneficiaries.
Permanent life insurance has benefits that extend beyond death benefits to beneficiaries. As you continue to pay your premium, your policy will accumulate a cash value that can be borrowed against. Borrowing from your life insurance policy can be an effective alternative to a standard bank loan since the only collateral is the policy itself. Still, you’ll want to speak with your adviser before considering a loan from life insurance, as any loan would be repaid with interest and could affect the death benefit from your policy.
A few considerations
While permanent life insurance can be a beneficial component of most estate plans, there are challenges to consider. Specifically:
- Higher premiums for permanent vs term life insurance
- Higher premiums or denial of coverage due to age or health conditions
- Policies are not FDIC-insured in the case of insurer insolvency
- Lower benefit to premium value in later years of policy
The primary challenge of permanent life insurance is that it becomes harder and more expensive to get as you age or if you have certain health challenges. That’s why it’s advantageous to get started with a permanent policy while you’re young and to keep up with the premiums to prevent the policy from lapsing. The solvency of the insurer can be an issue, but that can be mitigated by doing research and paying attention to the independent ratings agencies that grade them.
In his oft-quoted quip about death and taxes, Franklin was commenting on the projected permanence of the newly ratified U.S. Constitution — it had nothing to do with life insurance or finances. But when it comes to estate planning, the peace of mind of a burden-free benefit to your loved ones is worth consideration.
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