The Fundamentals of Life Insurance

Do you need life insurance?

Life insurance protects your family and dependents should something happen to you. If you have a family or spouse who depend on you for financial support or if you work at home providing your family with such services as childcare, you should consider life insurance. 

Older couples may need life insurance to protect a surviving spouse against the possibility of the couple’s retirement savings being depleted by unexpected medical expenses. 

Individuals with substantial assets may need life insurance to help reduce the effects of estate taxes or to transfer wealth to future generations. 

Other uses of life insurance include:

• Education – The cash value in a life insurance policy can provide funds for college education if the need for the death benefit decreases
• Charitable giving – Life insurance can fund a donation for a charity, church, foundation or nonprofit organization
• Mortgage and debt coverage – Life insurance may be used to pay off a mortgage, credit cards, student loans and other personal debt

What are the different types of life insurance?

The more common types of life insurance are term life insurance, whole (or permanent) life insurance, universal life insurance and variable life insurance.

How much life insurance do you need?

How much life insurance you need depends on many factors. Of course, a financial professional can help you decide how much is right for you. Alternatively, you may consider one of these two approaches:

A relatively simple and quick estimate may be to base the amount of insurance on your current, after-tax income (since life insurance is generally paid out tax-free); multiply this by the number of years your beneficiaries will need the income, and remember to make an allowance for inflation.

For a more detailed approach, determine your personal income replacement needs   by adding up your family’s regular expenses such as housing, health care, food, clothing, transportation expenses and the like; this represents the amount that your insurance will need to replace. At a minimum, you’ll want a death benefit amount that, when invested, will provide income annually to cover this amount.

To these you can add expected one-time expenses, such as your children’s college tuition or paying down mortgage or debt. And remember to account for day care, housekeeping or nursing care as needed. 

Finally, estimate your own “final expenses” such as estate taxes, uninsured medical costs and funeral costs.

Tax benefits of life insurance

There are a number of tax benefits to life insurance, including:

• Any earning accumulated in your life insurance policy’s cash value grows free from taxes. (Please note that in a variable life insurance policy, cash value growth is not guaranteed.)
• The death benefit of your permanent life insurance is generally passed on to your beneficiaries free from federal income tax.
• Premium withdrawals may be tax-free, depending on the type of coverage you have.
• Transfers among the underlying investment options of a variable life insurance policy are generally not subject to current income or capital gains taxes.
• Should your need for the policy’s death benefit decrease, you can take loans or withdrawals from a life insurance policy prior to age 59 ½ without the 10% early withdrawal penalty.

Estate planning benefits of life insurance

Life insurance is typically a critical element of a family’s estate plan. It may enhance the amount of wealth you can bequeath to your heirs and provide a ready source of cash for their financial obligations.

Those who own all or part of a business may also use life insurance as a tool for managing the transfer of the value of that business as part of an estate. For example, an entrepreneur may need to plan an estate in which his two adult children – one who works in his business and one who does not – are heirs. The owner could bequeath the business to the son or daughter who works there and designate the beneficiary of a life insurance policy with a value approximating that of the business.

Additionally, many business owners rely on life insurance proceeds as part of a business continuation agreement, enabling their business partners to acquire the ownership interest of a deceased owner’s heirs. The surviving owners could use insurance proceeds to purchase the interest of heirs who have no intention of managing the business. 

Advisors does not provide tax or legal advice. Please consult with your professional tax and legal advisors regarding your particular circumstances.

Selecting beneficiaries for your life insurance policy

Your beneficiary is the person who will receive your life insurance policy’s death benefit. For life insurance, no matter who is designated, the beneficiaries will generally receive the death benefit proceeds income tax-free. Unlike property disposed of in a will, if the beneficiary designation form is properly completed, insurance proceeds do not go through probate.

For many marries individuals, a spouse is the most logical beneficiary. A trust may be a prudent beneficiary choice, however, if a surviving spouse would not have the ability to prudently manage a large sum of money. The trustees – often a legal entity rather than an individual – would then take charge of managing, investing and disbursing the policy proceeds for the benefit of the surviving spouse.

Be sure to name contingent or secondary beneficiaries for your life insurance policy. This ensures that if the primary beneficiary has passed away, the insurance proceeds will go to an individual or trust. If there are no surviving beneficiaries, then your beneficiary is generally the “estate of the insured,” which means the death benefits end up being probated and ultimately distributed according to the instruction of the last will and testament. If there is no valid will (or the person has died without making a will, also known as “intestate”  ), then the order of legal beneficiaries to whom assets are distributed is specified by that state’s law.

Key life insurance terms and definitions

Below are key life insurance terms and definitions:

• Face Value – A life insurance policy’s death benefit amount.
• Convertibility – The option to convert from one type of policy (e.g., term) to another (e.g., whole life), usually without a physical examination.
• Cash Value – The accumulate cash value portion of a policy that can be borrowed against or withdrawn by partial or full surrender. Outstanding loans accrue interest, and loans or partial withdrawals will reduce the policy’s death benefit.
• Premiums – Monthly, quarterly or yearly payments required to maintain coverage. If you pay your premium other than annually, you will generally pay a higher premium than you would have if you paid your premium annually.
• Beneficiary – The individual(s) or entity (e.g., trust) that is designated to receive a policy’s death benefit upon the death of the insured.

Important information

1. Withdrawals from life insurance policies may be subject to fees, penalties, and income taxes depending on the specific life insurance policy and the policy holder’s tax situation. Withdrawals reduce the policy value and death benefit. Life insurance contains exclusions, limitations, and terms for keeping it in force. For costs and complete details contact a financial professional.
2. All guarantees are backed by the claims paying ability of the issuing company.
3. Variable investment options within variable life insurance policies are subject to fluctuation in value and market risk, including the possibility of loss of principal. Variable life insurance policies are sold by prospectus. Please consider the charges, risks, expenses and investment objectives carefully before purchasing a variable life insurance contract. For a prospectus containing this and other information, please ask your Financial Professional.  Read it and consider the information carefully before purchasing a policy.

This information is provided for informational purposes only. We encourages you to seek personalized advice from qualified professionals regarding all personal finance issues. 

Please be advised that this document is not intended as legal or tax advice.  Accordingly, any tax information provided in this document is not intended or written to be used, and cannot be used, by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer. The tax information was written to support the promotion or marketing of the transaction(s) or matter(s) addressed and you should seek advice based on your particular circumstances from an independent tax advisor.

Life insurance products are issued by Financial Life Insurance Company (New York, NY) or Financial Life Insurance Company of America, an Arizona stock corporation and are co-distributed by Network, LLC (Network Insurance Agency of California in CA; Network Insurance Agency of Utah in UT; Network of Puerto Rico, Inc. in PR), and Distributors, LLC. Variable products are co-distributed by Advisors, LLC (Member FINRA, SIPC)(Financial Advisors in MI and TN) and Distributors, LLC. When sold by New York based (i.e. domiciled) Advisors financial professionals life insurance products are issued by  Financial Life Insurance Company, (NY, NY).