DO I NEED LIFE INSURANCE?
Yes, if you have bills, a car loan, dependents, or a mortgage, you need life insurance. Life insurance is most commonly used to replace the income lost when a bread winner passes away prematurely. If you are the primary income earner and your income is needed to maintain the family’s standard of living, your dependents may suffer financially if you die. The policy’s death benefit can help fund your dependents’ ongoing financial needs.
HOW MUCH LIFE INSURANCE SHOULD I CARRY ON MYSELF?
Your future potential income can be considered your family’s most valuable asset because it allows you to meet the future living expenses and needs of your family. If you were to pass away your family’s living expenses are not going to go away and those who are financially dependent upon you will still be required to meet those financial obligations. Your need for life insurance and the amount required will depend on your personal and financial circumstances. If any of the following statements applies to you, you should speak to a licensed professional regarding life insurance: 1) You have a spouse 2) You have dependent. 3) You have a mortgage or other outstanding debts. 4) Your retirement pension and savings are not enough to insure your spouse’s future against a rising in the cost of living. 5) You have a large net worth/estate. 6) You own a business or are a partner in a business. 7) You have an aging parent or disabled relative who depends on you for support.
WHAT IS LIFE INSURANCE?
Life insurance is a contract between an insured and an insurance company. In the event of the insured’s death the life insurance company is required to pay out the contract’s face amount to the insured’s designated beneficiaries. The funds provided via a life insurance policy may be for your loved ones to use to meet their financial needs in the event of your death. You enter into a contract with an insurance company, which promises to provide your beneficiary(ies) with a certain amount of money (the death benefit) upon your death. In return, you make periodic premium payments. The amount of the premiums you pay will depend on factors such as your age, gender, occupation, medical history and whether you intend to build up cash value in your policy.
HOW DO I DETERMINE WHICH TYPE POLICY IS RIGHT FOR ME?
Some basic planning and fact finding should take place before buying a policy. Speaking with a licensed professional can help you determine the type of policy that will best meet your needs. Factors such as affordability, needs, and time frame should be taken into account.
WHY ARE INSURANCE COMPANY RATINGS IMPORTANT?
Ratings provided by independent rating agencies such as Standard and Poor’s, A.M. Best, Moody’s, Fitch and Weiss give indication of a company’s financial strength and claims paying ability. It is important to purchase a policy from a highly rated company to ensure that if you pass away your beneficiaries are paid in full.
WHAT IS THE DIFFERENCE BETWEEN TERM AND PERMANENT LIFE INSURANCE?
Term life insurance is often the most affordable and simple type of life insurance coverage. Term life policies do not build up a cash values. Coverage is remains in place for a fixed term or period of time, usually ten to 30 years, and may be renewed after the initial term. The policy pays your beneficiary a fixed death benefit if you die while the policy is in force. There are three types of Permanent life insurance: Universal Life, Whole Life, and Variable Universal Life insurance. Universal Life: insurance is a flexible life insurance plan. These policies are interest-sensitive and give the owner the option to adjust the death benefit and/or premium payments, within limits, to fit the owner’s situation. The net premium payments are applied to the accumulation fund, which earns a guaranteed interest rate. As with whole life insurance, the cash value belongs to the policy owner, who may withdraw it or borrow against it as provided for in the policy. Whole Life: provides protection as well as a guaranteed cash value. The premiums remain at a fixed level for the duration of the policy. Over time, the policy generally builds up cash value on a tax-deferred basis. Some companies pay a dividend, which is a return of excess premiums. Variable Universal Life insurance: is a life insurance policy that is based on the performance of the financial markets. Variable policies offer a policy holder a variety of mutual funds or professionally managed investment funds to invest the policy’s cash values. The values may accumulate more rapidly than with other cash value policies, but the policy owner incurs additional risk associated with the financial markets. If market performance is poor, the cash values and death benefit may decrease, which may results in the policy owner having to pay higher premiums to keep the policy inforce/in effect. As with whole life and universal life policies, policy owners may withdraw funds or borrow against the policy’s cash. It is important to keep in mind that loans and withdrawals may reduce cash values and the policy’s death benefit.
IS IT POSSIBLE TO CHANGE MY LIFE INSURANCE POLICY IF I ALREADY HAVE ONE?
The option to change or replace an existing life insurance policy can always be considered. You can replace your current policy, however, there are several items to consider when determining a change in coverage. If you want to increase your total life insurance, it may be wiser to keep your old policy and simply add a new one, or increase your specified face amount under the same life insurance policy (if allowed by the policy). A new policy will contain a contestable clause, which will permit the insurance company the option to contest any material misrepresentation. (The two year period on your current policy’s contestable clause may have expired.) Be sure to ask your agent, financial advisor or insurance company about the best alternative for your specific situation. Historically life insurance rates have continuously declined over time as people live longer and longer. This creates an opportunity to re-evaluate an existing policy periodically to see if cost savings can be achieved.
HOW ARE LIFE INSURANCE DEATH BENEFIT PROCEEDS TAXED?
The general rule is that death benefits paid to a beneficiary are received income tax free. This tax-free treatment of death benefits is only available if the policy is not transferred or sold for cash or other valuable consideration. *This is for information purposes only and is not to be taken as tax advice. Please consult a tax professional.
ARE ACCELERATED DEATH BENEFITS TAXABLE?
Life insurance death benefits paid out on the life of a terminally ill insured which are paid before the insured’s death may be income tax free. A terminally ill person is someone who has an illness that is expected to result in death within two years. Most life insurance policies issued today offer some type of accelerated death benefit feature for terminally ill insureds, but the accelerated death benefit amounts provided by a policy will vary. A chronically ill insured (one who is not terminally ill) may also be entitled to receive accelerated benefits tax-free, although fewer life insurance policies offer an accelerated benefit for chronically ill insureds. The amount the chronically ill insured can receive income tax-free from all life insurance policies and qualified long term care insurance is limited to the daily amount allowed under long term care insurance policies. *This is for information purposes only and is not to be taken as tax advice. Please consult a tax professional.
IS THE GROWTH OF CASH VALUES IN A LIFE INSURANCE POLICY TAXABLE?
As long as the life insurance policy’s cash values stays in the policy, any growth in the cash value is income tax-deferred. However, once the money is taken out of the policy, there could be tax implications. In general, a policyowner is not taxed on cash value amounts equal to the policy owner’s cost basis in the policy. The cost basis in a universal life and whole life insurance policy is roughly equal to the total amount of premiums paid into the policy. If the policy has riders attached to it, the total cost of the riders must be subtracted from the total premiums paid to determine cost basis. If a life insurance policy is surrendered/cancelled for its cash value, the cash received from the policy will be treated as taxable income only to the extent in which the amount received exceeds the policy owner’s cost basis in the policy. If the cash values are removed from the policy via withdrawals, the policyowner is not subject to tax on the amount equal to the policy owner’s cost basis in the policy. Only values received in excess of the policy owner’s cost basis are subject to income tax. Note: After the cost basis is completely removed from a policy, all additional withdrawals may be subject to tax. *This is for information purposes only and is not to be taken as tax advice. Please consult a tax professional.
IF A POLICY WITH AN OUTSTANDING LOAN BALANCE IS SURRENDERED, WHAT ARE THE TAX CONSEQUENCES?
All growth in the life insurance policy values is tax deferred. However, all growth/gains in the cash values of a policy are taxable upon withdrawal or surrender. See “Is the growth on policy cash value income taxable?” for more information on how cash value is taxed. If a policy with an outstanding loan is surrendered/cancelled, the amount of the loan paid off by the policy’s cash value will be treated as part of the cash amount received. If the policy has more cash value than is needed to pay off the outstanding loan, the excess amount is paid directly to the policyowner. To determine if there is a gain or loss upon surrender, add the net cash surrender value to the outstanding loan balance. And then compare that sum to the policy owner’s cost basis in the policy. If the amount exceeds the basis, the policyowner will need to treat the gain as taxable income. If the sum is less than the basis, the policyowner would incur a non-deductible loss. Losses upon the surrender of a life insurance policy are ordinarily and therefore are not income-tax deductible. If a policyowner has borrowed heavily against a life insurance policy before surrender, this can result in “phantom income.” This means that the policyowner may have more income tax liability than actual cash amount received from the policy. If this is the case, it may be important to ensure that the policy in question stays active and inforce. *This is for information purposes only and is not to be taken as tax advice. Please consult a tax professional.
ARE LIFE INSURANCE PREMIUMS DEDUCTIBLE?
Life insurance premiums paid by an individual are not usually deductible for federal income tax purposes. In most cases premiums paid by business for insurance policies on a key-man, to fund a buy-sell arrangement, or to use as collateral for a business loan, are not income tax deductible by the business. However, premiums paid by an employer to purchase group term life insurance on its employees are deductible, as long as the employer is not a direct or indirect beneficiary of the life insurance. *This is for information purposes only and is not to be taken as tax advice. Please consult a tax professional.
WHAT IS A SECTION 1035 EXCHANGE?
Internal Revenue Code §1035 states that certain life insurance policies may be exchanged tax-free for new a life insurance policy or annuity. For example, suppose a life insurance policy has a cost basis of $15,000 and a total cash value of $60,000. If the policyowner surrendered the policy, $45,000 would be treated as taxable income to the policy owner, even if the policyowner used the proceeds to purchase a new life insurance policy or annuity. However, if the policyowner exchanges the old policy for a new life insurance policy or annuity under IRC §1035, the policyowner will not have to include the gain as taxable income. The gain is rolled over to the new policy and the cash values continue to grow tax deferred. Certain rules must be followed to make certain the policyowner gets the benefits of a 1035 exchange, *This is for information purposes only and is not to be taken as tax advice. Please consult a tax professional.
WHAT IS A MODIFIED ENDOWMENT CONTRACT (MEC)?
A modified endowment contract (MEC) is a life insurance policy that has been issued or materially changed after June 21, 1988 and which fails to meet the “7seven-pay test.” To determine if a policy is a MEC, the total premiums actually paid during the first seven policy years are compared against the cumulative seven-pay test premiums. If the actual total premiums are less than the cumulative seven-pay test premiums, the policy is not a MEC. If they are greater, the policy is a MEC. *This is for information purposes only and is not to be taken as tax advice. Please consult a tax professional.