Why do people buy life insurance? More specifically, why do you buy life insurance?

Without life insurance, a financial plan is just an investment plan that will die when you do. People dream dreams. Without enough life insurance, your dreams will probably die when you do?

Most people have either an estate tax problem or an estate size problem. What does that mean? When you die, your estate will be subject to income taxes and estate taxes. Life insurance can provide the money to pay the taxes rather than liquidating other more valuable growth and income-producing assets. On the other hand, most people have an estate size problem. Life insurance helps creates wealth that they have not had enough time to accumulate themselves.

I’ve heard it said many times that if people truly understood life insurance, they would be lining up to buy it. Life insurance is a commonsense cash cushion to fall back on during your lifetime or for your family when you die. Think of it in this context. How would you feel about a bank savings account that pays higher interest than the bank over the long haul, and where the interest is either tax-free or tax-deferred, depending upon the degree of tax planning done? In addition to that, there is a tax-free death benefit. Over the long haul, it will quite probably substantially outperform the bank.

Buying life insurance is a reflection of common sense, caring, commitment, and character. It is about doing the right thing for yourself and your family. General Norman Schwarzkopf said, “The truth of the matter is that you always know the right thing to do.  The hard part is doing it.” This statement certainly applies to life insurance.

Life insurance only makes sense if you are going to die. Coming to grips with that fact is not so easy for everyone. No one has a lease on life. If you don’t die before age 65, you will die after age 65. It is bad enough to die. Don’t do it for free.

Most of us understand that we have a responsibility to our families. It is easy to say you love someone. Buying life insurance means putting your money where your mouth is. As General Schwarzkopf said, we know the right thing to do. As he also said, we need help doing it. That is why most people need a life insurance agent to help them do the right thing.

The commercial featuring that loud, quacking duck has gone a long way to making people think about individual disability coverage as a way to keep bills paid if the family breadwinner gets sick or injured over an extended period of time.

It’s true — individual disability insurance is more important than ever, and every working individual should have it.

The key is shopping smart for that coverage. A financial planning professional is a good first stop for advice on that coverage, which should be considered as part of an overall financial plan.

Why is it a good idea to have personal disability coverage, particularly when most employees can buy such coverage at work for a nominal fee? That’s because most employers offer disability coverage that lasts 12 weeks or less and covers less than 60 percent of a worker’s pretax income. That might be workable for a surgery or injury with a relatively quick recovery time on the couch, but a diagnosis for even the most curable cancers can put workers with even the best financial coverage into a devastating financial bind.

And if you are self-employed, the need for the best, most flexible long-term disability insurance is even more important because other than your own resources, that coverage will be your own safety net.

Here are some essential things to know about long-term disability coverage. Remember that policy language is critical, and a financial planner can give you a second, helpful set of eyes to review what your insurance agent recommends:

If you’re considering becoming self-employed or might lose your job due to layoff: The time to buy long-term disability coverage is NOW. Insurers will base your initial coverage limits on what you’re earning in your current job, which is important since entrepreneurs and unemployed often earn considerably less – at least for awhile — once they’ve left their current employer.

Make sure you can purchase more coverage as your income increases: Because you stand to earn more in future working years – if only based on inflation – you should make sure your benefit levels can rise to meet the demands of replacing that income if you need to in the future. Obviously, people who expect to make vastly higher salaries in the future need to plan for this.

Check for a non-cancellation feature: Make sure that once you’re approved, the insurer can’t cut your coverage unless it decides to stop writing coverage for everyone in your job class. It should also state that the insurer can’t raise your rates based on the benefits you’re to receive.

Compare benefits and premium cost: Get bids from several carriers and consider going to more than one agent. The premium you pay will depend on a wide array of factors and can vary dramatically from person to person. Such things as your age and your gender (women pay more for disability insurance because they currently tend to live and work longer, for example) will be a factor in what you pay.

Go for “own occupation” coverage: Even if you are able to work in a different capacity, own-occupation disability insurance will provide you with the income replacement you need if you are unable to work in your current occupation. Make sure you understand how that coverage fits your current profession.

Know what “elimination period” means: Like a deductible in home, health or car insurance, the elimination period is a big cost determinant in disability coverage. (It’s actually a big factor in long-term care policies as well.) Most long-term disability policies will kick in after 30 days after you’ve been declared disabled. But if you specify an elimination period of 60, 90 or 120 days, your premium will be lower. An important point about the 30-day elimination period:  the benefits don’t start accumulating until you’ve been laid up a month after the ruling date and you won’t get your payment until a month after that. Be very clear with your insurer when you’ll get your first check based on what elimination period you choose, and make sure you have a cash cushion to cover that need in your emergency fund.

What’s your benefit term: For each disabling incident, your policy may pay benefits for a certain period – two, five years or until retirement. It’s all in how your policy is constructed. Many policies may pay for life if you purchase this benefit and you are disabled prior to age 60. Also, make sure there’s language that increases your benefits as your income increases over time.

See if there’s a residual benefit feature: Some policies may offer you ‘residual benefits’ or a partial payment if you’re less than 100 percent disabled, but still can’t perform all the duties of your job.

April 2010 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Martin V. Higgins, CFP, CLU, AEP, a local member of FPA.

If you’ve never taken notice of disability coverage before, it’s time to start.

Disability insurance protects your ability to earn an income. It provides money to pay your rent, mortgage and basic living expenses if you are injured or sick for an extended period. It is called disability insurance or disability income protection but think of it as income replacement when you are sick or hurt and cannot work. At any age, you are about six times more likely to become disabled for some period of time than to die.

Think your employer’s coverage is enough? Think again. You may have whatever sick leave you have coming, and then if an employer offers short-term disability coverage, it generally doesn’t last more than 12 weeks. There are employers that offer long-term disability coverage, but if you’ve never checked the terms of that coverage, you should.

It never hurts to consult a financial advisor with expertise in this subject, such as a CERTIFIED FINANCIAL PLANNER™ professional.

Basic components of long-term disability coverage:

Monthly benefits:

Depending on your income, long-term disability insurance is generally structured to pay 50 to 70 percent of your income up to age 67 or your normal retirement age. Research if the policy you’re buying offers you the chance to buy more insurance as your income increases in future years.

Benefit term:

For each disabling incident, your policy may pay benefits for a certain period – two or five years, or until retirement. It’s all about how your policy is constructed. Some policies even pay for life if you purchase this benefit and you are disabled prior to age 60.

Buying younger is generally cheaper:

Like health and life insurance, the younger you buy, the less you’ll pay. Occupation enters into the picture because high-risk jobs (where disability is a greater work-related factor) tend to draw more claims. Like health insurance, the company will consider your medical history and your lifestyle, including your weight, pre-existing conditions and whether or not you smoke.

Premium cost:

The premium will depend on a wide array of factors and can vary dramatically from person to person. Such things as your age and your gender (women pay more for disability insurance because they tend to live longer and may work longer) will be considered.

Non-cancellation provisions:

Make sure that once you’re approved, the insurer can’t cut your coverage unless it decides to stop writing coverage for everyone in your job class. It should also state that the insurer can’t raise your rates.

Guaranteed renewable:

Like the category above, this means your insurance can’t be canceled,. The insurer can, however, raise the rates for everyone in the category.

Own occupation vs. any occupation:

If you have “own occupation” coverage, it is intended to go into effect if you can’t perform the functions of your current job. “Any occupation” coverage pays only if you can’t work at any job where you’ve been reasonably trained to do the tasks. For example, if you’re working a desk job, you could easily be transferred to a receptionist’s job or some other function within the company that you can now do or is your former position. That could significantly interfere with your recovery time, so consider the benefits and specify “own occupation” coverage.

Elimination period:

Like a deductible in home, health or car insurance, the elimination period is a big cost determinant in disability coverage. Most policies will start paying after 30 days after you’ve been declared disabled. But if you specify an elimination period of 60, 90 or 120 days, your premium will be lower. An important point about the 30-day elimination period:  the benefits don’t start accumulating until you’ve been laid up a month after the ruling date and you won’t get your payment until a month after that. Be very clear with your insurer when you’ll get your first check based on what elimination period you choose, and funnel the money you’ll need in the meantime to your emergency fund.

Partial payments/Residual benefits:

Some policies may offer you ‘residual benefits’ or a partial payment if you’re less than 100 percent disabled, but still can’t perform all the duties of your job.

If you’re thinking about self-employment:

You’ll likely need disability coverage. But the time to buy is while you’re still in your current job. Why? You won’t be able to prove your income once self-employed, so consider obtaining your desired coverage before you leave.

February 2010 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Martin V. Higgins, CFP, CLU, AEP, a local member of FPA.

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If you’ve never taken notice of disability coverage before, it’s time to start.

Disability insurance protects your ability to earn an income. It provides money to pay your rent, mortgage and basic living expenses if you are injured or sick for an extended period. It is called disability insurance or disability income protection but think of it as income replacement when you are sick or hurt and cannot work. At any age, you are about six times more likely to become disabled for some period of time than to die.

Think your employer’s coverage is enough? Think again. You may have whatever sick leave you have coming, and then if an employer offers short-term disability coverage, it generally doesn’t last more than 12 weeks. There are employers that offer long-term disability coverage, but if you’ve never checked the terms of that coverage, you should.

It never hurts to consult a financial advisor with expertise in this subject, such as a CERTIFIED FINANCIAL PLANNER™ professional.

Basic components of long-term disability coverage:

Monthly benefits:

Depending on your income, long-term disability insurance is generally structured to pay 50 to 70 percent of your income up to age 67 or your normal retirement age. Research if the policy you’re buying offers you the chance to buy more insurance as your income increases in future years.

Benefit term:

For each disabling incident, your policy may pay benefits for a certain period – two or five years, or until retirement. It’s all about how your policy is constructed. Some policies even pay for life if you purchase this benefit and you are disabled prior to age 60.

Buying younger is generally cheaper:

Like health and life insurance, the younger you buy, the less you’ll pay. Occupation enters into the picture because high-risk jobs (where disability is a greater work-related factor) tend to draw more claims. Like health insurance, the company will consider your medical history and your lifestyle, including your weight, pre-existing conditions and whether or not you smoke.

Premium cost:

The premium will depend on a wide array of factors and can vary dramatically from person to person. Such things as your age and your gender (women pay more for disability insurance because they tend to live longer and may work longer) will be considered.

Non-cancellation provisions:

Make sure that once you’re approved, the insurer can’t cut your coverage unless it decides to stop writing coverage for everyone in your job class. It should also state that the insurer can’t raise your rates

Guaranteed renewable:

Like the category above, this means your insurance can’t be canceled,. The insurer can, however, raise the rates for everyone in the category.

Own occupation vs. any occupation:

If you have “own occupation” coverage, it is intended to go into effect if you can’t perform the functions of your current job. “Any occupation” coverage pays only if you can’t work at any job where you’ve been reasonably trained to do the tasks. For example, if you’re working a desk job, you could easily be transferred to a receptionist’s job or some other function within the company that you can now do or is your former position. That could significantly interfere with your recovery time, so consider the benefits and specify “own occupation” coverage.

Elimination period:

Like a deductible in home, health or car insurance, the elimination period is a big cost determinant in disability coverage. Most policies will start paying after 30 days after you’ve been declared disabled. But if you specify an elimination period of 60, 90 or 120 days, your premium will be lower. An important point about the 30-day elimination period:  the benefits don’t start accumulating until you’ve been laid up a month after the ruling date and you won’t get your payment until a month after that. Be very clear with your insurer when you’ll get your first check based on what elimination period you choose, and funnel the money you’ll need in the meantime to your emergency fund.

Partial payments/Residual benefits:

Some policies may offer you ‘residual benefits’ or a partial payment if you’re less than 100 percent disabled, but still can’t perform all the duties of your job.

If you’re thinking about self-employment:

You’ll likely need disability coverage. But the time to buy is while you’re still in your current job. Why? You won’t be able to prove your income once self-employed, so consider obtaining your desired coverage before you leave.

December 2009 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Martin V. Higgins, CFP, CLU, AEP, a local member of FPA.

If you’ve never taken notice of disability coverage before, it’s time to start.

Disability insurance protects your ability to earn an income. It provides money to pay your rent, mortgage and basic living expenses if you are injured or sick for an extended period. It is called disability insurance or disability income protection but think of it as income replacement when you are sick or hurt and cannot work. At any age, you are about six times more likely to become disabled for some period of time than to die.

Think your employer’s coverage is enough? Think again. You may have whatever sick leave you have coming, and then if an employer offers short-term disability coverage, it generally doesn’t last more than 12 weeks. There are employers that offer long-term disability coverage, but if you’ve never checked the terms of that coverage, you should.

It never hurts to consult a financial advisor with expertise in this subject, such as a CERTIFIED FINANCIAL PLANNER™ professional.

Basic components of long-term disability coverage:

Monthly benefits:

Depending on your income, long-term disability insurance is generally structured to pay 50 to 70 percent of your income up to age 67 or your normal retirement age. Research if the policy you’re buying offers you the chance to buy more insurance as your income increases in future years.

Benefit term:

For each disabling incident, your policy may pay benefits for a certain period – two or five years, or until retirement. It’s all about how your policy is constructed. Some policies even pay for life if you purchase this benefit and you are disabled prior to age 60.

Buying younger is generally cheaper:

Like health and life insurance, the younger you buy, the less you’ll pay. Occupation enters into the picture because high-risk jobs (where disability is a greater work-related factor) tend to draw more claims. Like health insurance, the company will consider your medical history and your lifestyle, including your weight, pre-existing conditions and whether or not you smoke.

Premium cost:

The premium will depend on a wide array of factors and can vary dramatically from person to person. Such things as your age and your gender (women pay more for disability insurance because they tend to live longer and may work longer) will be considered.

Non-cancellation provisions:

Make sure that once you’re approved, the insurer can’t cut your coverage unless it decides to stop writing coverage for everyone in your job class. It should also state that the insurer can’t raise your rates.

Guaranteed renewable:

Like the category above, this means your insurance can’t be canceled,. The insurer can, however, raise the rates for everyone in the category.

Own occupation vs. any occupation:

If you have “own occupation” coverage, it is intended to go into effect if you can’t perform the functions of your current job. “Any occupation” coverage pays only if you can’t work at any job where you’ve been reasonably trained to do the tasks. For example, if you’re working a desk job, you could easily be transferred to a receptionist’s job or some other function within the company that you can now do or is your former position. That could significantly interfere with your recovery time, so consider the benefits and specify “own occupation” coverage.

Elimination period:

Like a deductible in home, health or car insurance, the elimination period is a big cost determinant in disability coverage. Most policies will start paying after 30 days after you’ve been declared disabled. But if you specify an elimination period of 60, 90 or 120 days, your premium will be lower. An important point about the 30-day elimination period: the benefits don’t start accumulating until you’ve been laid up a month after the ruling date and you won’t get your payment until a month after that. Be very clear with your insurer when you’ll get your first check based on what elimination period you choose, and funnel the money you’ll need in the meantime to your emergency fund.

Partial payments/Residual benefits:

Some policies may offer you ‘residual benefits’ or a partial payment if you’re less than 100 percent disabled, but still can’t perform all the duties of your job.

If you’re thinking about self-employment:

You’ll likely need disability coverage. But the time to buy is while you’re still in your current job. Why? You won’t be able to prove your income once self-employed, so consider obtaining your desired coverage before you leave.

December 2009 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Martin V Higgins, CFP,CLU, AEP, a local member of FPA.

You have finally retired. Your children are secure. Your grandchildren are your greatest joys. You have some funds that you don’t think you will have to use for your retirement that you would love to leave to your grandchildren. But, in today’s volatile economy, where is a safe place to put it? Is there a safe place that can hedge against market fluctuations?

In considering the answers to these questions, don’t overlook one of the safest and simplest tools, life insurance. Many people overlook life insurance because they are in good health and feel that they can invest the money elsewhere for larger returns. However, if the senior does not anticipate needing the money for a number of years, but wants to be able to easily access it should it become necessary, and safety and simplicity are their goals, then life insurance should definitely be considered. Life insurance looks even better if there is a strong likelihood that the senior will not use the money.

Mr. Singleton is 60 years old, a standard non-smoker and has a substantial sum to invest. Currently, he is in a 35% tax bracket. He has sought advice because he wants to hedge all of the current market fluctuations, but still have a good return. He hopes that he can leave it to his grandchildren.

He finds that he can use the lump sum available for investing as a single premium for a whole life policy. The life insurance^† would have a face amount of approximately two times the single premium for a whole life (permanent) life insurance contract.

Graph 1

In Graph 1, the blue line represents the death benefit of the new life insurance policy. The graph compares an alternative savings program ^‡ earning 5% before taxes every year. At life expectancy, 18.2 years for a male age 60, the life insurance death proceeds would be about 25% greater than that of the alternative savings plan. The breakeven point would be after 24 years – if death occurred prior to age 84, the life insurance would have the greater gains. If death occurs after age 84, the alternative savings would have the larger gain.

The life insurance values and gains are very attractive if death occurs in the next 24 years. But what if Mr. Singleton needs the money for an emergency, or whatever? Although some values could be obtained from the permanent life insurance, the values would be less than those of the alternate savings program, as seen in Graph 2.

Graph 2

Even though Mr. Singleton thinks he will hold this investment until death, he must consider the values available for an emergency.

Of course, the rate of return for the life insurance is very high if death occurs in an earlier year. The alternative savings has been assumed to earn 5% before taxes throughout.

Graph 3

Graph 3 shows the life insurance returns will be quite high if death occurs sooner than life expectancy, but only slightly lower if death occurs after life expectancy.

Life insurance that has almost no market fluctuations is a very good long-term asset, especially if it is anticipated that it will be held until death.

PlanLab News provides no investment advice nor does it offer any opinion with respect to the suitability of any transaction. Clients should consult their legal, tax, and/or financial advisor before taking actions based on this information.

^† Based on a major US life company’s policy illustration for a standard male non-smoker with a one-time premium payment of $100,000.

^‡ The 5% return is hypothetical earnings for purposes of this illustration. It is assumed that 35% of the earnings each year are used to pay the taxes on the earnings.

Findings from the “Woman’s Guide to Long Term Care Insurance Protection”, a publication of  The American Association for Long Term Care Insurance (AALTCI), indicate that women who are older than 65 comprise 980,000 nursing home residents in the U.S. This is compared to only 337,000 men in that age group.

According to the Association’s Executive Director Jesse Slome, women benefit more from owning LTC insurance, as two-thirds of all insurance benefits are paid to women.

• 41 percent to single women and 25 percent to married women = 66%
• 12 percent to single men and 22 percent to married men = 34%
• The 2000 census found that there were 20.6 million women age 65 and over, compared with 14.4 million men, i.e. 50% more women than men.
• So, out of every 1000 seniors 600 are women and 400 are men•
• LTC stats say that 60% of all Americans over age 65 will need some kind of LTC before they die, i.e. 600 out of every 1000•
• Therefore 400 women and 200 men out of every 1000 seniors eventually use long-term care.
• Conclusion, women are 50% more likely to use long-term care than men.

If you would like to receive a “Woman’s Guide to Long Term Care” go to www.savethespouse.com or call us 24 hrs a day @ 856-988-7722 x2 and order your FREE copy today!

Maximizing Your Pension with Life Insurance

Introduction

If you participate in a traditional pension plan (known as a defined benefit plan) with your employer, you may receive monthly benefits from the plan after you retire. These benefits are generally based on your age at retirement, as well as your years of service and your average earnings with the company. Depending on your plan’s provisions, you may have more than one payout option to choose from. You want to select an option that will provide you with sufficient retirement income. In addition, if you are married, you want to be sure that your spouse will have sufficient income in the event that he or she outlives you.

When you retire, a defined benefit plan must offer you and your spouse a joint and survivor annuity. If your spouse consents in writing, you can generally decline the joint and survivor annuity and elect a single-life annuity instead. Some defined contribution plans offer similar options, so consult your plan administrator or benefits department if you participate in one of these plans.

With a joint and survivor annuity, payments continue as long as either you or your spouse is alive. When one spouse dies, the benefits paid to the surviving spouse generally cannot be less than 50 percent (or more than 100 percent) of the joint benefits. By contrast, with a single-life annuity, payments last for your lifetime and cease upon your death. For example, if you received one payment after retirement and then died, the single-life annuity would provide no further payments from your pension. Your spouse would receive nothing.

So why would you choose a single-life annuity knowing that payments will stop at your death? One reason is that the single-life annuity generally pays a larger monthly benefit than the joint and survivor annuity. This is because the payments are designed to last for a smaller number of years (i.e., one life expectancy instead of two). Retirees who want to maximize their monthly income sometimes choose the single-life annuity for this reason. The retiree can then use the additional income to purchase life insurance with his or her spouse as the beneficiary, thereby protecting the spouse’s financial future. This strategy, commonly called pension “maximization” using life insurance, may be appropriate for you.

Caution: Be sure to seek qualified professional advice, since choosing a pension payout option and life insurance coverage can be complex and will impact both your financial future and your spouse’s.

Factors to consider

Difference in benefits between the two payout options

As mentioned, a single-life annuity pays larger monthly retirement benefits than a joint and survivor annuity. The amount of the difference is a key factor when deciding between the two payout options. This information is generally provided to you prior to distribution as part of the spousal consent/waiver process. If the single-life annuity pays significantly more than the joint and survivor annuity, then electing the single-life annuity along with the purchase of a life insurance policy may be a viable strategy. The larger the monthly benefits under the single-life annuity, the more income you will have to pay the premiums for the life insurance policy. However, if the difference between the two payout options is relatively small, it may be better to elect the joint and survivor annuity. This is especially true if the single-life annuity will not provide enough income to pay the insurance premiums.

Tip: Always consider the impact of federal and other income taxes on annuity payments when determining the net amount of benefits available for you (and your spouse).

Insurability and cost of insurance

If you are not insurable because of your health and/or other reasons, then electing the single-life annuity along with the purchase of a life insurance policy is not an option. If you are insurable, determine how much life insurance coverage would be needed to compensate your spouse for the loss of your pension income if you elected the single-life annuity. Then look at the cost of that amount of coverage, and compare it with your monthly income from the single-life annuity. This will help you decide if using the pension maximization strategy makes financial sense. If you are relatively young and in good health, the insurance premiums may be much more affordable than if you are older and/or in poor health. However, as the cost of the insurance becomes more expensive, using life insurance to maximize your pension payout becomes less attractive.

Cost-of-living adjustment

Some pension plans have a cost-of-living adjustment (COLA) feature that allows the monthly benefits to be periodically increased to keep pace with the rate of inflation. If your pension contains this feature, you may need to consider a larger insurance policy to protect your surviving spouse from the loss of your pension income (assuming you elect the single-life annuity). This is because your surviving spouse would receive an ever-increasing amount of annual income over his or her lifetime if you elected the joint and survivor annuity with a COLA feature, and the rate of inflation goes up over time. Thus, the presence of a COLA clause in your pension plan may be a factor against using life insurance to maximize your pension. You will have to work through the numbers to see if it makes more sense to elect the single-life annuity and buy an insurance policy, or to simply elect the joint and survivor annuity.

Health and life expectancy of your spouse

If your spouse is in poor health or has a short life expectancy, then selecting the single-life annuity along with the purchase of a life insurance policy often makes more sense than selecting the joint and survivor annuity. This strategy is more practical if your spouse is more likely to die before you. As the plan participant and the surviving spouse, you will then have the benefit of the higher monthly payout from the single-life annuity for the rest of your life. You can then choose to discontinue the life insurance policy, or continue to make the premium payments and name a new beneficiary (as long as an irrevocable designation of beneficiary has not been made).

Age difference between you and your spouse

If there is a large difference between your age and your spouse’s age (with you being much older), then opting for the single-life annuity along with the purchase of a life insurance policy may make more sense because the difference in benefits between the single-life annuity and the joint and survivor annuity will typically be greater. If your spouse is considerably younger than you, his or her longer life expectancy will be factored into the calculation of the joint and survivor annuity benefits, resulting in smaller monthly payments. This could leave you and/or your spouse without sufficient retirement income using a joint and survivor annuity. However, if you select a single-life annuity that ends because you die soon after retiring, your much-younger spouse may have to survive financially without the benefit of your pension for a long period of time.

Gender of the plan participant

If you (the plan participant) are female and insurable at an affordable cost, then selecting the single-life annuity along with the purchase of a life insurance policy may make more sense than selecting the joint and survivor annuity. The reason: All other factors being equal, women are statistically more likely to outlive men of the same age. You will benefit from the higher monthly payout under the single-life annuity while you are alive, and the life insurance coverage will protect your spouse in the event that you die first. By contrast, if you select the joint and survivor annuity and your spouse dies first, you may be stuck with a smaller payout for the rest of your life (unless the plan has a “pop-up” provision–see below).

“Pop-up” provision

Some pension plans offer their participants a “pop-up” provision specifying that if they initially select a joint and survivor annuity payout and the spouse dies first, they can then retroactively select a single-life annuity payout. This gives you flexibility to adapt if things do not go as planned. If your pension plan offers this option, you may not want to select a single-life annuity with the purchase of a life insurance policy. It may be better to initially select the joint and survivor annuity.

Advantages of maximizing your pension with life insurance

It may increase your retirement income

Most people who use a single-life annuity with life insurance to maximize their pension payouts are trying to increase their income during their retirement years. Under most pension plans (and depending on various factors such as the age of the two spouses), a single-life annuity will pay out substantially more per month than a joint and survivor annuity. Most people would like to have that extra income during their retirement years. However, most people are also concerned about providing for their spouses if they should die first. By selecting a single-life annuity along with the purchase of a life insurance policy on the participant’s life, some couples can increase their income during retirement and provide for the surviving spouse’s financial future.

It may work well even if the nonparticipant spouse dies first

Using life insurance to maximize your pension payout will work well financially if your nonparticipant spouse should die first. In fact, this strategy may actually produce greater financial benefits if your nonparticipant spouse does die first, because you (the surviving spouse) will receive the higher single-life annuity payout for the rest of your life. You can then either discontinue the insurance policy or name a new beneficiary and continue to pay the premiums.

It may provide assets for your heirs and beneficiaries

Another benefit to selecting the single-life annuity with the purchase of a life insurance policy is that there may be assets left over for your heirs and beneficiaries. If you and your spouse select a joint and survivor annuity, no benefits from your pension plan will be paid to your heirs and beneficiaries (e.g., your children) when the surviving spouse finally dies. If, however, you select a single-life annuity and purchase a life insurance policy on your life, some of the insurance proceeds may still be left for your heirs and beneficiaries after the death of your surviving spouse. This is especially true if your surviving spouse invests the proceeds wisely and does not spend them rapidly, or if your spouse predeceases you and the life insurance proceeds are paid to your beneficiaries upon your death.

Disadvantages of maximizing your pension with life insurance

The income earned on the insurance proceeds may not meet expectations

This strategy may not work well if, for some reason, the investment earnings on the insurance proceeds are too low to adequately provide for the surviving spouse. To illustrate, consider the following hypothetical scenario.

Example(s): Upon your retirement, you select a single-life annuity for your pension and purchase a $300,000 life insurance policy on your life with your spouse as beneficiary. Based on market conditions at the time of your retirement, you believe that the earnings generated by the insurance proceeds will provide sufficient income for the rest of your spouse’s life if you die first. You die three years later, when market conditions have deteriorated substantially. The life insurance proceeds may now not provide enough income for your surviving spouse.

Your surviving spouse may squander the insurance proceeds

Another potential problem with this strategy is that your surviving spouse may make poor investments with the insurance proceeds, spend them too quickly, or otherwise squander the money. If this happens, your surviving spouse may be in a difficult financial situation for the remainder of his or her lifetime. With the joint and survivor annuity, you minimize this risk because your surviving spouse would at least be assured of receiving the designated pension payout each year.

The life insurance policy may lapse

If you choose to maximize your pension with life insurance and then stop paying the insurance premiums due to financial problems or other reasons, the insurance policy may lapse. With no insurance proceeds and no pension benefits, your surviving spouse may be in a difficult financial position after your death. In this case, your surviving spouse would have been in a much better position if the two of you had selected the joint and survivor annuity for your pension.

When this strategy makes sense: a short case study

Example(s): Assume you are about to retire at age 65, and your spouse is age 62. Your pension plan gives you the option of either a single-life annuity or a joint and survivor annuity. If you select the single-life annuity, you will receive $4,500 per month for the rest of your life, but your spouse will receive nothing if you die first. If you select the joint and survivor annuity, you and/or your spouse will receive $3,000 per month as long at least one of you is alive. That’s an additional $1,500 per month (or $18,000 per year) with the single-life annuity.

That sounds attractive, but what will happen to your spouse if you select the single-life annuity and you die before your spouse? Your spouse gets no survivor benefit. Your spouse may need a way of replacing that lost pension income. One way to accomplish this may be to purchase a life insurance policy on your life, and name your spouse as the beneficiary of the policy.

You need to determine whether the extra $1,500 per month under the single-life annuity (less income taxes) will buy enough insurance coverage to produce a replacement income of $3,000 per month if you die before your spouse. That is the amount of income your spouse would have received had you selected the joint and survivor annuity. You also need to determine whether your spouse will live off of only the income from the insurance proceeds, or need to dip into principal as well. You must run the numbers to see what is affordable and what makes financial sense.

Income tax considerations

The monthly retirement benefits you and your spouse receive from your pension are generally treated as taxable income, subject to federal (and possibly state and local) income tax. This is true regardless of whether you elect a single-life annuity payout or a joint and survivor annuity payout. However, since the pension benefits are larger with a single-life annuity, electing this payout option will increase your taxable income during retirement.

If you elect the joint and survivor annuity payout, when the first spouse dies, the pension payout to the survivor will be included in the survivor’s taxable income. If you instead use the pension maximization strategy and die before your spouse, the life insurance death benefits will not be included in your surviving spouse’s taxable income. This is because life insurance death benefits generally pass free from income tax to the beneficiary of the policy. Of course, your surviving spouse may invest the insurance proceeds in taxable investments. Any earnings from such investments (e.g., interest, dividends, and capital gains) will generally be included in your spouse’s taxable income.

Caution: While life insurance proceeds are generally free from income tax to the beneficiary, estate taxes are another matter. If this is a concern, you should consult a qualified estate planning attorney for appropriate strategies.

Forefield Inc. does not provide legal, tax, or investment advice. All content provided by Forefield is protected by copyright. Forefield is not responsible for any modifications made to its materials, or for the accuracy of information provided by other sources.

From time to time, you may need to resolve a dispute with your insurance company. Disagreements often arise about the amount due on a bill, the amount the company paid on a claim, or the nonpayment of a claim. Here are some steps that can help you resolve a dispute efficiently and agreeably.

Know your rights

The insurance industry is highly regulated. Your state has laws that dictate what insurance companies can and cannot do when it comes to bill collecting, settling claims, and other matters. The law may be called the Unfair Insurance Practices Act, the Unfair Claims Settlement Practices Act, or something similar. To learn about the laws in your state, call your state insurance department or check its website. Most states have the following regulations in place:

• An insurance company cannot misrepresent your policy. In other words, the company cannot knowingly tell you that the policy means something that it doesn’t actually mean. In addition, the company cannot change the policy without informing you in writing ahead of time.
• The company cannot withhold payment on a claim against one part of your policy in order to force an issue on a claim against another part of your policy. For example, your insurer cannot withhold payment on a claim against the collision portion of your auto policy to force you to settle on the liability portion.
• Companies must acknowledge and process claims promptly. In some states, companies have to acknowledge within 15 days that they received notice of a claim. After receiving the claim, they must investigate, process, and settle it quickly.
• Companies cannot ask you for unnecessary forms in an effort to delay an investigation or payment of a claim.
• Companies cannot make it a practice to appeal most court awards that favor their policyholders. Companies are allowed to appeal decisions they truly believe are unfair, but they cannot use the appeal process to force their policyholders to settle for less than they are due.
• A company has to have a good reason to deny or delay a claim and must explain the reason to the policyholder. In most cases, lack of coverage or nonpayment of premiums is the reason for a denied claim. Or, the company could be misinformed about the details or circumstances of the claim.

Use your insurance agent or broker

If you have an insurance agent or broker, he or she can be a valuable resource in resolving disagreements amicably. Your agent or broker has an established relationship with the insurance company and knows where to go for help. An agent or broker can usually resolve the problem over the phone right from his or her office. Give him or her your policy number, copies of disputed bills, canceled checks, any written correspondence, and records of any phone conversations. If you don’t have an insurance agent or broker, discuss the problem with a customer service representative from the company.

Write a letter

If you’ve had no luck resolving the problem through your agent or broker or by calling the company, write a letter to the appropriate manager at the company. For example, address letters regarding disputed bills to the accounting or finance manager. If possible, obtain the manager’s name before writing the letter. Your letter should clearly state the problem and what you think would be a fair resolution. Include information about phone conversations you had with customer service representatives, such as dates of the calls and the names of the people you spoke with. Your letter should also include your policy number and your daytime telephone number. Finally, include copies of written correspondence, bills, canceled checks, or bank statements.

Get a third party involved

Complaints rarely come to this point, but if your company still hasn’t resolved the problem to your satisfaction, there are a number of options you can pursue. Calling your state’s insurance department is one such option–there are state insurance regulators who investigate policyholder complaints. In fact, if the state finds that the company is violating any state laws or regulations, the state could fine or otherwise reprimand the company. You might also consider contacting your state’s consumer protection division or the Better Business Bureau. Another option is to seek an out-of-court settlement through arbitration or mediation. There are independent organizations that will provide this service when you have a dispute with your insurer.

Take legal action

As a last resort, you can take the insurance company to court. If the amount in question is below a certain threshold (this amount varies by state), small-claims court may be an option for you. You do not need an attorney in small-claims court.

If the amount is too big for small-claims court, you can hire an attorney. It is in the insurance company’s best interest to settle disputes quickly, especially if they involve expensive litigation. Chances are good that once you hire an attorney and he or she contacts the insurance company, the dispute will be settled out of court.

If you educate yourself, have all the information at your fingertips, stay organized, and be persistent, you should be able to resolve your problem quickly.

Forefield Inc. does not provide legal, tax, or investment advice. All content provided by Forefield is protected by copyright. Forefield is not responsible for any modifications made to its materials, or for the accuracy of information provided by other sources.

The purpose of life insurance is to provide a sum of money (the death benefit) at the death of the insured. When you use life insurance as part of your college-funding plan, you can provide funding for your child’s college education in two ways. The first and perhaps obvious use is the death benefit, which can be used to pay for your child’s college education should you die prematurely. Statistically speaking, you probably will be alive to see your child through college, in which case you can still use life insurance as part of your education-funding plan. When you choose a cash value life insurance policy, you have a second way of reaching your college-funding goal. When you pay premiums on a cash value policy, some of your money is applied towards the policy cash value, making it sort of a savings account within the life insurance policy. Cash values accumulate and can be used during your lifetime via withdrawals and/or policy loans. This discussion assumes that you will live beyond the time your child enters college, and it will focus on the potential benefits of using cash value life insurance in your plan for funding your child’s college tuition.

When can it be used?

You have a need for insurance

Life insurance can be an important tool in your savings plan for your child’s college education. However, it is not appropriate that you buy life insurance solely for funding college tuition. You should only consider life insurance for this purpose when you also have a need for life insurance protection. Need is determined by several factors. If you work and produce an income that your family depends on, there is likely an insurance need. Even if you don’t work outside the home but are responsible for the care of your children, there may be an insurance need. The worksheet How Much Insurance Do You Need? will give you a guideline to help you and your financial planner determine appropriate levels of life insurance coverage.

Tip: If you already have insurance, review your existing coverage every few years. Changes in your life (such as salary increases, marriage or divorce, the birth or adoption of a child, or purchase of a residence) may indicate a need for a change in coverage.

You have a long time before tuition funds are needed

Insurance companies often charge the policy expenses such as fees and commissions in the earlier years of the policy. Because of this expense front-loading, several years could pass before your policy cash values begin to accumulate to sizable amounts. It is generally recommended that cash value insurance be considered for purchase when you intend to hold it for a long period of time, usually at least 10 or 15 years.

Tip: Check your existing policies. If you already have life insurance with cash values (remember that policy you bought 10 years ago?), you may have a head start on your funding plan for your child’s college education.

Strengths

Your family is provided with life insurance protection

Unlike other investments or a savings account, life insurance provides your family with a death benefit (i.e., a sum of cash paid after your death). Generally, the amount of the death benefit is significantly larger than the total premiums paid for the policy. If you should die before your child enters college, tuition can be paid from the policy death benefit. Should you live (which is much more likely), you can use policy cash values to pay for some or all of your child’s tuition. Your family still receives the benefit of life insurance as long as the policy remains in force.

Policy cash values grow tax deferred

The portion of your premium payment that is applied to cash value is invested either by the insurance company or at your direction, depending on the type of policy. Positive investment returns increase the cash value. You are not subject to taxes on the growth in cash value until you withdraw the cash values or cancel (surrender) the policy. It is possible that you may be able to withdraw cash values and not be subject to income tax on the withdrawal. For more information, see the section on tax implications.

Diverse investment choices are available for cash values

The cash values in your life insurance policy are invested in investment vehicles that traditionally have the potential to earn higher returns than an ordinary savings account at a bank. The investment options (normally called subaccounts) usually include bonds or stocks. You can buy a life insurance policy that lets you select the specific investments, or you can leave the investment choices up to the professional investment managers with the insurance company. In either case, you have the potential for higher returns (but also greater potential for loss) than if you made deposits to a traditional passbook savings account.

Tip: Read the fine print concerning the underlying investments for the insurance policy you are interested in. Shop around until you find a policy with cash value investments you are comfortable with.

Caution: Variable life and variable universal life insurance policies are offered by prospectus, which you can obtain from your financial professional or the insurance company. The prospectus contains detailed information about investment objectives, risks, charges, and expenses. You should read the prospectus and consider this information carefully before purchasing a variable life or variable universal life insurance policy.

Cash values can be withdrawn

When the time to pay college tuition arrives (or you need the money for any other purpose), you might withdraw some or all of the cash value from your policy, much like a withdrawal from a bank account. The amount you can withdraw is generally limited to a percentage of the cash value and varies by policy and company. You may be able to withdraw from your cash values and still keep your insurance in effect to provide a death benefit at your death.

Tip: It’s a good idea to leave enough cash value in the policy to maintain the policy and cover the policy fees.

Caution: Cash value withdrawals may reduce the death benefit.

Cash values can be borrowed against

Cash values can be borrowed against using a policy loan. Policy loans are allowed under the terms of your insurance contract and are not affected by your current financial position. In other words, you don’t have to undergo a credit check or a bank loan approval process for a policy loan. When you take a policy loan, the check you receive comes out of the general funds of the insurance company, not your cash value. Your policy cash value serves as the loan collateral. The interest rate for a policy loan is known in advance and may be lower than that on a bank loan.

Tip: Some policies allow borrowings at an interest rate only slightly higher than the rate being credited to cash values. With some policies, the loan interest rate charged equals the rate credited to cash values, for a zero net cost loan.

Caution: If either your dividends or the increases in cash value are reduced, this is also part of your cost to borrow.

Caution: If you die with an outstanding policy loan against your account, your death benefit is reduced by the amount of the outstanding loan balance.

Caution: Interest accrues on the unpaid loan balance. If you choose not to repay the loan, the accruing interest could erode your cash values and result in a policy lapse with some types of policy.

You can combine withdrawals with policy loans

Cash value withdrawals and policy loans are not exclusive events. You can use a combination of withdrawals and loans to maximize the tax-free cash withdrawal benefits. You might choose to make cash value withdrawals up to the amount of your policy basis and then take a policy loan. In insurance terms, this is referred to as “surrender to basis and switch to loan.”

Example(s): Let’s say you have a son you are putting through college. You own a cash value policy that you bought just after he was born, and you are considering accessing your cash values to pay this year’s tuition. The first thing you might do is to make a tax-free withdrawal of cash value from the policy equivalent to the amount of premiums you have paid into the policy. After you withdraw to your basis, you take a policy loan.

Insurance policy can be gifted to your child

As the owner of a life insurance policy, you may be able to transfer ownership to someone else by gift. As part of your overall financial and estate planning, you may choose to gift the policy to your child. To attain the maximum allowable tax benefit from your policy, you may want to withdraw cash value equivalent to your basis in the policy before you make the gift.

Example(s): Let’s say you have a daughter you are putting through college. You own a cash value policy that you bought when she was very young. She doesn’t have an income because her “job” at present is that of an unpaid archaeologist working on a project in France. You are considering making a gift of your cash value insurance policy to your daughter. Before you make the gift, you may be able to make a tax-free withdrawal of cash value from the policy equivalent to the amount of premiums you have paid into the policy. In insurance terms, this is referred to as a withdrawal to basis. After you complete the withdrawal to basis, you gift the policy to your daughter. As the new owner, she can now withdraw from the cash value. Her withdrawals will be taxed at her income tax rate, which presently is considerably lower than your rate. Another option is for her to take a policy loan against the remaining cash value.

Caution: Depending on the amount of the cash value gifted, part of it may be considered a taxable gift. Also, you may need to continue the gift with additional gifts of the premiums in order to keep the policy in force. Otherwise, your low-income college student may not be able to make the premium payments, and the policy could lapse.

Life insurance values are not included in federal methodology for financial aid

Under the federal financial aid formula, assets are grouped into two categories: assessable and nonassessable. Life insurance policies fall into the nonassessable category. In other words, the value of your cash value life insurance is not counted as income or assets in the financial need calculation. The amount of federal financial aid your child is eligible for is not reduced because you have life insurance containing cash value.

Although life insurance values are not included in the federal methodology, many colleges and universities do look at these values when assessing financial need and assistance at the school level.

Tradeoffs

You must be insurable

In order to get life insurance, you must be considered insurable by an insurance company. Insurability can be affected by such factors as medical history, age, or participation in dangerous hobbies such as auto racing. Life insurance is not available to people in extremely poor health, although few people are actually refused insurance.

Tip: Even if you have a history of health problems, you may still be able to buy a rated policy. The premiums are higher than for a preferred policy (whose favorable premiums reflect the fact that the applicant is less likely to die than a standard applicant), but your need for insurance protection may make it worth the expense.

Premiums represent financial obligation

Once you buy a life insurance policy, there is often an ongoing expense: the premiums. In the early years of the policy, the premiums represent a contractual obligation. Obviously, when you pay premiums, you have less cash available for other purposes.

Tip: In the later years of the policy, you may be able to reduce the amount of premiums you pay. This depends on the type of policy, so check out the details of your policy. With some policies, you can reduce your death benefit when your need for insurance is reduced (e.g., when your child has completed college). The death benefit reduction would be accompanied by a reduction in your premiums. Check the policy for details.

Amount of insurance must be justifiable

When you buy life insurance, you purchase a policy with a stated death benefit, also called the face amount. An appropriate death benefit is calculated beginning with your current income and your economic life (i.e., what you can be expected to earn during your working lifetime). There are several ways to calculate a life insurance need, but in the end, the death benefit must be justifiable in order to satisfy the insurance company’s financial underwriting process.  As a result of this death benefit limitation, your cash value potential is also limited. For instance, a 30-year-old person with an income of $30,000 would not be eligible to buy the same amount of insurance as a 50-year-old person with an income of $1 million.

Your cash value contributions may be limited

Because life insurance contracts receive favorable income tax treatment, the government has restricted the amount of money that can be paid into policies that are treated as life insurance contracts for tax purposes. There are specific rules that define a life insurance contract for tax purposes. These rules limit the amount of cash you can put into a policy that is treated as a life insurance contract.

There may be a death benefit restriction

If the cash value in a policy is too high relative to the policy death benefit, cash value increases will be taxed instead of being allowed to grow tax deferred. The excess cash value must be distributed to you. The cash value might become too high relative to the death benefit if the underlying investment experiences high returns or if the death benefit is reduced. In addition, the size of the policy you are eligible to buy is limited by your age and income under the financial underwriting requirement that the amount of insurance be justifiable.

You may be subject to modified endowment contract (MEC) rules

The modified endowment contract (MEC) rules were established to prevent people from using life insurance policies as tax-free investments for large sums of money. The MEC rules limit the amounts you can pay into a policy during the first seven years of the policy’s life. If you exceed the limits, the policy is permanently classified as a MEC and is subject to special tax rules. Under these rules, policy loans are generally taxable, and withdrawals are not only taxable but may also be subject to a 10 percent penalty tax.

Underlying investments subject to fees, potential losses

The underlying investments in a cash value policy may be subject to losses, depending on the performance of the investment and the markets. Just as investment gains are added to your cash value, losses may be deducted, depending on the specific policy. Investments are also subject to management and administrative fees.

Tip: Read your contract and prospectus concerning the underlying investments and any associated fees before you choose a policy.

What factors should you consider when choosing a policy?

When planning for college expenses, parents are often concerned with four areas: tax benefits, financial aid, control issues, and investment costs. Generally, all types of cash value life insurance will provide you with the same benefits in the areas of tax benefits and financial aid. The major difference between various policy types occurs in the areas of control and costs. The following types of life insurance all contain cash value and may be used for funding your child’s college education.

• Whole life
• Variable life
• Universal life
• Variable universal life

Tax benefits

The following tax characteristics are common to all types of cash value life insurance.

• Cash value grows tax deferred
• Cash value withdrawals to basis are not taxable
• Policy loan proceeds are not subject to income tax
• Death benefit is generally received by beneficiary free from income tax

Financial aid

Some assets, like cash value life insurance, may be treated differently depending on who is doing the financial analysis, the government or a college.

• Federal financial aid methodology doesn’t include policy cash values in parents’ total assets when determining a child’s financial need
• Individual colleges may consider policy cash values when determining a child’s financial need

Control issues

In all cases, when you own a cash value life insurance policy, you control the policy. You can decide if withdrawals are to be taken when allowed under your policy or if you want to take a policy loan. You choose the policy beneficiary who will receive the death benefit when you die. However, between the various types of cash value policies, there are differing levels of control over the cash value investments and premium payments. These may be key factors in choosing the appropriate life insurance type for saving for your child’s college education while also protecting your family’s income at your death.

Control over cash values

You have two options concerning your policy cash values. You can choose from investments offered by the policy, assume the investment risk, and monitor the performance of your cash values, or you can leave that to the insurance company’s fund manager.

Control over premium payments

All life insurance policies require some payment of premium. However, depending on the policy you choose, you may be able to control the timing and amount of your premium payments. You might want to pay a fixed amount that is due on a specified date that you can budget for indefinitely. On the other hand, you may want the flexibility to decide if you will occasionally pay a larger or smaller premium or skip a payment altogether. You may want to pay your premium in an up-front lump sum, thereby eliminating future payments.

Investment costs: Premiums

When you buy life insurance, you incur a direct cost–the premiums you pay for the policy. Premiums generally include the cost of the insurance protection as well as certain administrative expenses, risk charges, and processing costs. With universal life and variable universal life policies, the expenses are itemized in the policy prospectus. With whole life and variable life, the expenses and charges may be bundled (i.e., you can’t easily determine and compare charges for individual items).

Tip: Often the expenses are front-loaded; that is, the expenses and charges are deducted directly from each premium payment, with the balance of the premium payment being credited to the cash value account.

The significance of premium differences

It may be tempting to compare different policies based solely on the premium amount. This method may not be reliable, however. Many policies receive dividends from the insurance company that are based on the company’s investment returns or expense experience. Even if a policy seems to have a high premium, if the policy also receives high dividends, its cash values accumulate rapidly. Moreover, if it receives high interest credits, it may actually be less costly than a policy with a lower stated premium.

Tip: Check with your financial planner. There are several different formulas for comparing policy costs. The policy with the lowest premium may not actually be the least expensive.

Fees, penalties, and charges

In addition to premiums, there may be other fees, penalties, and charges related to your policy. If you withdraw cash value or take a policy loan, the insurance company may charge a processing fee. If you take a cash withdrawal or a policy loan, there are costs you incur in the form of foregone interest on the amount of the withdrawal or loan, not to mention the interest that accrues on the loan amount. If you choose to cancel the policy, there may be surrender charges involved, which will vary depending on how early or late in the life of the policy the cancellation occurs. Some policies carry a 15- to 20-year surrender schedule.

Tip: If you already own life insurance, check your policy and consult your agent about fees and interest charges if you are considering a cash withdrawal or policy loan.

Tip: If you are in the process of buying a policy, compare several policies before you make your choice. Fees and processing charges can vary by company and policy type.

What are the tax implications?

Income Tax

Premium payments not deductible

Life insurance premium payments are not tax-deductible expenses.

Cash withdrawals may not be taxable

Life insurance policy cash value withdrawals are considered a nontaxable recovery of your policy basis until the entire policy basis has been withdrawn. There are special rules for policies that are classified as a modified endowment contract (MEC), which are not discussed here.

Example(s): Say you own a life insurance policy (non-MEC) with a cash value of $15,000. Your basis in the policy equals $12,500. You plan to take a withdrawal of $7,000 now to pay for part of your son’s tuition. You won’t have to pay tax on this withdrawal amount because it will be considered a return of your basis.

Caution: Withdrawals in excess of your basis are treated as taxable distributions of interest or gain.

Caution: Cash value withdrawals that occur in the first 15 years of the policy and are accompanied by a reduction in the face amount may be treated as ordinary income to the extent that the cash value of the policy exceeds the policy basis.

Policy loans generally not taxable

When you take out a loan against your life insurance policy (except a modified endowment contract (MEC), the amount you receive is not considered taxable income. This rule applies even when the loan is larger than the amount of premiums you have paid in (except in the case of a MEC).

Example(s): Say you own a life insurance policy (non-MEC) with cash value of $20,000. Your basis in the policy is $17,000. You decide to take a policy loan to pay your daughter’s tuition. Under the terms of your policy, you are allowed to take a loan for an amount up to 90 percent of the policy cash value–in this case, $18,000 ($20,000 x.90). You are not subject to tax on the amount of the loan, even though the loan is larger than your basis.

Policy loan interest not deductible

Interest you pay on a policy loan is generally not a deductible expense (under certain circumstances, interest on loans used for business or investment purposes may be deductible).

Policy cancellation may be taxable

If you cancel (surrender) your policy for cash, the gain on the policy is subject to federal income tax. The gain on a canceled policy is the difference between (1) the net cash value and any loan forgiveness amounts, and (2) your policy basis.

Caution: If you surrender your policy while there is an outstanding policy loan, there could be additional tax consequences.

Death benefits generally not subject to federal income tax

Policy death benefits are generally not subject to federal income tax.
Gift Tax

Policy proceeds not considered gift to beneficiary

When the proceeds of your life insurance policy are paid to a beneficiary other than yourself (as the owner-insured) or your estate, they are not treated as a gift for gift tax purposes.

Policy premium payments generally not subject to gift tax

When you are the owner of a policy on your own life, with another party as the beneficiary, premium payments made by you are not considered a gift to the beneficiary for gift tax purposes. If, however, someone else pays the premiums on a policy you own, the premium payments are considered a gift to you and may be subject to federal gift tax if the annual premiums exceed the annual gift tax exclusion.
Estate Tax

Policy proceeds included in estate value in some cases

The proceeds of a life insurance policy are included in the value of your estate if you held any incidents of ownership at any time during the three years before your death or if the proceeds are payable to you or your estate. Some examples of incidents of ownership include the right to change the beneficiary, to take out policy loans, or to surrender the policy for cash.

Policy proceeds often exempt from state inheritance tax

In many states, life insurance proceeds are exempt from state inheritance taxes.

April 2009 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Martin V Higgins,CFP , a local member of FPA.