Do I Need Life Insurance?

Life insurance serves a variety of purposes but, at the core, it transfers risk. At death, many of us would leave obligations behind – families who depend on our income, estate tax bills that need to be paid, or a business that needs funding for succession to the next owner. Life insurance transfers risk for that obligation to an insurance company in exchange for a premium – simple.

However, life insurance is really an umbrella term for a variety of financial tools that can be used to fill a few specific needs. There are two primary categories of life insurance:

Term life insurance provides a fixed payout when you die and a fixed cost, called a premium, for a term of usually 5–30 years. After the fixed period, the policy expires or premiums increase dramatically.

This type of coverage is best used to protect your family for temporary needs like repaying a mortgage or providing for dependent kids.

Permanent life insurance is designed to last as long as you do, whether that’s 45 years or 105 years. Though costs are typically higher than term life insurance in the early years, they offer added benefits like guaranteed death benefits for life and the ability to build tax-sheltered cash value, which can be used during your life.

This type of coverage is best for permanent needs like passing wealth to future generations, paying estate taxes, and giving to charitable organizations at death, and/or as an additional tax shelter for building wealth.

There are several kinds of permanent life insurance, each with unique characteristics. Here’s a brief overview.

• Whole Life provides fixed costs for the life of the policy, a guaranteed minimum death benefit, and a guaranteed minimum growth rate on your cash value with potential for additional non-guaranteed growth.
• Universal Life is commonly used like permanent term insurance to pass on a guaranteed death benefit for the lowest dollar. It offers more flexibility than Whole Life, like being able to vary your premium payments, but guarantees and cash value growth are typically weaker.
• Indexed Universal Life offers premium flexibility and a guaranteed minimum death benefit, like Universal Life. Cash growth, however, has more upside potential because it is linked to a market index like the S&P 500, but with guaranteed minimum “floor” and maximum “cap” on annual interest.
• Variable Universal Life also offers premium flexibility and guaranteed minimum death benefits, but your cash is invested in market-based “subaccounts” like mutual funds and ETFs, giving it the highest upside (and downside) potential but with no guarantees on growth.*

Your need for life insurance depends on whether you have a need that it serves well. Here are four primary goals life insurance can meet and which type of life insurance fits well.

Income Protection

Do others depend on your income? If so, how will you provide for them if you die and they no longer have your income? If you are 40 years old and make $250,000 annually, you’ll earn $7.5 million over the next 30 years – how much of that $7.5 million do you want your family to receive if you die within that time?

Home and car insurance is often mandated to protect others. While there’s usually no legal requirement to protect your income for your family, the IRS generally treats life insurance death benefits as tax-free to encourage individuals to protect their families.

Income protection can be solved with term insurance if you’re looking for the lowest cost option to provide temporary coverage for this single need. Permanent insurance, or a term/permanent combination, also meets the need well if paired with one of the next three needs.

Passing Wealth for Estate Taxes, Charity, or Family

Many of your financial goals continue after your death. You may want to provide liquidity for estate taxes, provide for future generations of family, or give generously to causes you care about. Life insurance takes a stream of payments during your life and compounds them into an income tax-free benefit for these goals after you’ve passed.

• Paying estate taxes. If you accumulate a significant amount of wealth in real estate or a family business, your family might be stuck with a large estate tax bill when you die. Kids are often left having to sell the business or real estate to pay those taxes. Instead, consider purchasing life insurance inside an Irrevocable Life Insurance Trust. This provides cash to pay taxes outside your estate, so they won’t add to the tax bill.
• Providing for future generations of loved ones. Continue the example above. You have a large part of your wealth in a family business. But, what if you have four kids and only two want to be involved in the business when you die? You can leave the company entirely to your two business-savvy kids. What about the others? Consider making them beneficiaries of life insurance owned by a Wealth Replacement Trust outside of your estate. You’ve still cared well for them without leaving them as owners of a company they’re not interested in.
• Giving to charity. Are there causes you support now? Would you like to give to them when you pass away? If so, life insurance can compound the dollars already earmarked for charity into an even greater gift.

These estate, charity and family needs are best met with some form of permanent life insurance since these needs and goals don’t go away over time. Term life insurance can be a temporary solution, but the goal is to make sure funds are available whenever you die, not just for a fixed timeframe.

Tax-sheltered Wealth Building

Are you saving aggressively for retirement and frustrated by the limits on 401(k)s and IRAs? Consider permanent life insurance designed specifically for wealth building. Wealthy and high income individuals often have permanent life insurance on their balance sheet because it builds cash value and, when structured properly, can become a powerful tax-sheltered tool. A few tips to make the most of this strategy:

1. “Maximum fund” your policy. When you contribute to a permanent life insurance policy, part of your dollar goes to cost, and part goes to cash value. Like your 401(k), your permanent life insurance policy has a limit on the amount you can save, but the limit depends on the size of the death benefit, rather than being a fixed number. The closer you are to that funding limit, the more of your dollar goes to cash value.
2. Choose your policy based on your risk tolerance. Do you want to build wealth outside the stock market? Are you willing to give up some of the upside to have guarantees when the market slides? Or do you prefer something that uses the stock market to take on more risk in hopes for higher returns? The strategy you choose affects how your cash value grows, so choose accordingly.
3. Commit for the long run. If you stop funding your 401(k) after a year, you’ll see that small nest egg grow bit by bit over time. However, if you intend to fund a permanent life insurance strategy for 20 years, but stop after a year or two, you’re likely to see the cash you accumulate get eaten up by cost over time. Some policies can be designed to work very well with a single lump sum payment or a limited number of payments, but this must be designed in advance.

When using cash value life insurance as a wealth-building tool, these tips can help you make the most of your chosen strategy. And, if you don’t end up spending those funds, they pass tax-free to your loved ones or causes you care about.

Buy-Sell Agreements and Business Succession Planning

If you own a business with multiple partners, you might use life insurance along with a Buy-Sell Agreement to enable surviving owners to purchase a deceased partner’s interest, protecting both the business and the family. This can be done with term insurance if cashflow is tight, or permanent insurance if your secondary goal is providing retirement benefits for exiting owners. For an in-depth look at this topic, read Buy-Sell Agreements in Business Succession Planning.

As your financial situation gets more complex, it becomes more likely that you might need to solve several of these problems at once. This is where consulting your advising team – ideally one that understands the pros and cons of insurance in a comprehensive financial plan – can bring clarity to complex decisions and give peace of mind knowing you’re using the right tools for the job, whatever that might be.

*Variable life insurance is sold by prospectus. Please consider the investment objectives, risks, charges, expenses, and your need for death-benefit coverage carefully before investing. The prospectus, which contains this and other information about the variable life policy and the underlying investment options, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest. The investment return and principal value of the variable life policy are not guaranteed. Variable life sub-accounts fluctuate with changes in market conditions. The principal may be worth more or less than the original amount invested when the policy is surrendered.