term life

What Many Don’t Get About Insurance

Need is always predicated on thoroughly understanding your objectives

Key Takeaways

  • The cost of funding estate taxes, without insurance, is substantial.

  • Insurance cash values are similar to owning a long-term bond portfolio with no mark-to-market risk.

  • The “invest the difference” argument holds up only if you are young.



I recently sat down with a very successful professional who finally acknowledged that he needed life insurance to protect the value of his company for his family. He is under 50 and recently bought some term insurance. He was now willing to discuss funding a larger permanent plan that would pay out if he lives to his life expectancy or beyond.

My client had the usual objections I hear from HNW clients and prospective clients. His first objection was typical of someone who is contemplating a large policy:

1. “Do I really need it?

2. “How should I pay for it?

3. “Why shouldn’t I just stick with term, since it is so much less expensive?”

 

These mental hurdles come up frequently, and any top insurance advisor is able to delineate the issues and help you through the maze of confusion that shrouds this decision. What is the best solution? Let’s look at the first big consideration--need. Some of you don’t care that much about what happens after you die. Others of you want every nickel to go to your family. Still others don’t mind paying some tax, but you want to preserve your best assets and heirlooms for your family. If your goal in estate planning is to preserve your estate for the benefit of your heirs, keep in mind that the cost of paying the taxes and fees from cash flow or liquidity is a form of self-insurance. You not only lose the use of your funds, but you also lose the future earnings.

The cost of funding estate taxes, without insurance, is substantial. Who is going to finance the tax if you don’t have the liquidity? What is it going to cost your family to get liquid? The cost of insurance is a mere percentage of the true cost of the tax. But if you are self-insured, you not only pay the full cost of the tax, but you also pay “taxes on the tax” as well as an interest cost. Self-insurance is not cheap. This is something you have to understand and believe. Do the math. The “invest the difference” argument holds up only if you die young.

 

You set the rules


Buying term and investing the difference is like trying to compare incomparable asset class returns. This is like saying, “My stock portfolio will beat your bond portfolio.” If we go by historic returns, then this is a true statement most of the time. But there have been a few times when bond returns did beat stocks, even with mark to market risks.

Just think this through carefully. When you invest this difference, where will you invest that sum of money? Will you invest it in fixed return assets, with little or no downside risk, or will you invest it in risky assets that are illiquid and have the potential for total loss? Are you going to buy growth stocks and hope the long-term bull market never pulls another 2008 nosedive?” To make this discussion academic, we need to compare similar asset classes with similar risks. Insurance cash values are similar to owning a long-term bond portfolio with no mark to market risk.

Conclusion

Ask yourself, “Are all your assets deployed in high-risk, low-liquidity investments, or do you own any liquid, low-return assets?” If it’s the latter, then ask yourself if you would rather own the bonds in a tax-free wrapper that provides long-term discounted dollars, or in a taxable world where you can lose 10 to 20 percent of the value if interest rates rise?

If you or someone close to you has concerns about their life insurance coverage, please contact us any time. We’d be happy to help.

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

Buying Life Insurance: What Kind and How Much?

You are likely to need life insurance if others depend on you for financial support, if you provide your family with such services as child care, if you need to consider protecting a surviving spouse or if you have accumulated substantial assets. There are several types of life insurance that you may want to consider.

Types of Insurance

•  Term insurance is the most basic, and generally least expensive, form of life insurance for people under age 50. A term policy is written for a specific period of time, typically between one and 10 years, and may be renewable at the end of each term. Premiums increase at the end of each term and can become prohibitively expensive for older individuals. A level term policy locks in the annual premium for periods up to 30 years.

•  Whole life combines payment protection with a savings component. As long as you continue to pay the premiums, you are able to lock in coverage at a level premium rate. Part of that premium accrues as cash value. As the policy gains value, you may be able to borrow up to 90% of your policy's cash value tax-free.

•  Universal life is similar to whole life with the added benefit of potentially higher earnings on the savings component. Universal life policies are also highly flexible in regard to premiums and face value. Premiums can be increased, decreased or deferred, and cash values can be withdrawn. You may also have the option to change face values. Universal life policies typically offer a guaranteed return on cash value, usually at least 4%. You'll receive an annual statement that details cash value, total protection, earnings, and fees. Drawbacks include higher fees and interest rate sensitivity -- your premiums may increase when interest rates rise.

•  Variable life generally offers fixed premiums and c ontrol over your policy's cash value, which is invested in your choice of stocks, bond, or mutual fund options. Cash values and death benefits can rise and fall based on the performance of your investment choices. Although death benefits usually have a floor, there is no guarantee on cash values. Fees for these policies may be higher than for universal life, and investment options can be volatile. On the plus side, capital gains and other investment earnings accrue tax deferred as long as the funds remain invested in the insurance contract.

How Much Insurance Do I Need?

A popular approach to buying insurance is based on income replacement. In this approach, a formula of between five and 10 times your annual salary is often used to calculate how much coverage you need. Another approach is to purchase insurance based on your individual needs and preferences. In this instance, the first step is to determine how much income you need to replace.
 
Start by determining your net earnings after taxes (insurance benefits are generally income tax free). Then add up your personal expenses (food, clothing, transportation, etc.) This will provide an idea of the annual income that your insurance will need to replace. You'll want a death benefit which, when invested, will provide income annually to cover this amount. Remember to add amounts needed to fund one-time expenses such as college tuition or paying down your mortgage.
 
Purchasing the right type of insurance in an amount that is suitable for your family's needs is an important element in financial planning. You may want to consult an advisor who can help you implement the details.

 
Source:

© 2008 Standard & Poor's Financial Communications. All rights reserved.

Required Attribution

Because of the possibility of human or mechanical error by Wealth Management Systems Inc. or its sources, neither Wealth Management Systems Inc. nor its sources guarantees the accuracy, adequacy, completeness or availability of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. In no event shall Wealth Management Systems Inc. be liable for any indirect, special or consequential damages in connection with subscriber's or others' use of the content.

© 2016 DST Systems, Inc. Reproduction in whole or in part prohibited, except by permission. All rights reserved. Not responsible for any errors or omissions.

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary lic ensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc . cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.