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Life Insurance As Part Of Your Estate Planning

Life insurance should play an important role in your estate planning. It can provide for the replacement of lost income if there is a premature death, provide cash to pay Pennsylvania inheritance tax and federal estate tax, and fund buy-sell obligations for business owners.

It’s important for you to periodically review your life insurance to make sure the right type of policies are in place and that you have adequate coverage. The type of policy needed (term, whole life, universal life) will depend on the purpose of the life insurance. The amount of coverage needed will either be a function of the income to be replaced, the cash needed for taxes, or the amount of the buy-sell obligation.

Types of Life Insurance Policies
An understanding of the types of life insurance policies is important to understand life insurance due diligence. Generally speaking, there are three types of life insurance policies – term, whole life, and universal life.

A term life insurance policy offers a death benefit but does not have any cash value. Term life insurance is the cheapest type of coverage and the most common. Normally, the premium for coverage will not increase during the policy period (normally 10-30 years).

Whole life insurance is a type of permanent life insurance coverage. The premium for coverage is the same each year and as long as the premium is paid the policy will remain in force. A whole life policy will build cash value, although at the outset of a policy the cash value builds slowly due to charges against the premiums. Whole life policies can provide a guaranteed minimum return and often provide for the payment of dividends from the life insurance company. Whole life policies normally are the most expensive type of policy offered by a life insurance company since the death benefit is guaranteed provided premiums are paid.

Universal life insurance is another type of permanent life insurance. The cash value of the policy grows more slowly than with whole life, and the amount of premiums paid by the insured can vary year to year. Universal life insurance policies often provide a guaranty period during which the policy will not lapse provided a minimum amount of premium is paid each year and on time. Variations of universal life include variable universal life (the premiums are invested in mutual funds) and indexed universal life (the earnings of the policy are pegged to one or more stock indices and provide the earnings cannot exceed a cap, such as 12%, but also cannot go below a floor, such as 0% growth).

Expenses of Life Insurance
All life insurance policies have expenses. The two primary expenses are the “cost of insurance” or “mortality” charge and the administrative expenses. The cost of insurance expense is based on the life expectancy of the insured (that is, the cost is a function of the likelihood the insured will die based on the insured’s age and health). The administrative charges consist of the commission paid to the life insurance agent and operational expenses of the life insurance company. Several life insurance companies have recently issued cost of insurance notices to their policy holders as a result of the low interest rate environment for investments. An increase in the cost of insurance will negatively impact the policy’s cash value.

The Importance of Life Insurance Due Diligence
Given the importance of life insurance in estate planning, it is important to periodically review your life insurance policies to make sure you have the right type of policy, the proper amount of coverage, and that the policy (if whole life or universal life) is not in jeopardy of lapsing. Some considerations and options include:

  • Do you have enough coverage? It’s generally recommend to have enough life insurance to pay off any secured debts (for example, your home mortgage) and to replace 5-7 years of income.
  • Conversely, do you have too much coverage? If so, you can reduce the face value of the policy to reduce your premium costs.
  • Should you exchange your current policy for a new policy? The exchange of an older policy with cash value often can result in a newer policy with a larger death benefit, better premium structure, or more advantageous policy features and options.
  • Do you have coverage for enough time? If you have a term life insurance policy, you may need to convert the policy to a permanent type of product assuming there is a conversion feature.
  • Does your whole life policy or universal life policy have sufficient cash value to prevent a policy lapse? For example, the failure to pay premiums or other borrowings against cash value may have reduced the cash value.
  • Should you sell your policy as part of a “viatical settlement”? There are investors who will purchase the right to receive the insured’s benefit in exchange for an upfront payment to the policy owner. This arrangement may make sense for an insured who has a policy in risk of lapsing or who does not want to continue to make premium payments to keep the policy in force.

If you have a whole life or universal life policy, you should periodically request an “in-force illustration.” These illustrations provide you with important information like the current cash value and the likelihood of how long the policy will last using the actual policy performance and the current cost of insurance and administrative charges.

Life insurance is an important part of any estate plan. Its uses and purposes will vary based on your situation. No matter who you are or what you do, everyone should carefully consider what type of insurance to purchase and should periodically evaluate the need and purpose of the insurance.