Introduction To Life Insurance And Annuities
If you are planning to purchase a life insurance policy or an annuity contract, you should first consider your needs and understand the different type of insurance products that are available.; Many more consumers are using life and annuity products as part of their financial planning goals.; Consumers spend substantial sums of money each year on life insurance policies or annuity contracts knowing very little about what it is that they are getting.; This guide was developed to help consumers make educated decisions and to help them understand both the benefits and the risks involved in financial planning.
Icipating Whole Life Insurance And Dividends
If a life insurance company or policy is referred to as participating, it means that the policy holder is actively participating in the funding of the policy.;As a participant, the policy holder is then entitled to receive dividends which are a portion of profits that are received by the company.
Better yet, dividends paid that do not exceed the total amount of premiums paid into the policy are viewed, by the IRS, as a return of those premiums and NOT taxable income.
Thus dividends offer one of the key tax advantages of whole life insurance when it comes to cash accumulation.
A Key Downside To Variable Life Insurance
Every permanent life insurance policy comes with fees but the downside to variable life insurance is that it tends to have the highest. Variable life insurance policies will typically have the following costs:
|These vary depending on how you choose to invest the policys cash value.|
|Surrender charges||Policies have a surrender period during which, if you withdraw part of the cash value or decide to give up your coverage, you will pay fees. The cash value of your policy typically isnt equal to its actual surrender value for the first 10 to 15 years of coverage.|
|Withdrawal fees||Each time you withdraw money from the policys cash value you can be charged a fee. This is often relatively small, around $25.|
|Policy loan interest||If you take out a policy loan using the cash value as collateral, the insurer will charge interest on the loan.|
|Riders||Riders are add-ons that can be used to alter the terms of the policy. Each needs to be evaluated as compared to its cost and your financial situation.|
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Life Insurance For Cash Value Accumulation
One of the key attributes of cash value life insurance is the ability to build reserves of cash within the policy. However, most people dont really understand the various ways that cash can accumulate within a permanent life insurance policy OR the pros and cons of using life insurance for cash accumulation.
Among the various types of permanent life insurance, cash can actually accumulate in a number of different ways based upon the policy and the strategy chosen. The pros and cons of using life insurance for cash value accumulation also vary based upon the policy type and strategy you use. This article is a walk through of these topics in hope of shedding some light on this confusing area.
Financial entertainers who profit from market based investments often poo poo life insurance by insisting that it isnt an investment. To these folks, apparently throwing your chips into the stock market constitutes prudent investing. More difficult to swallow, is the suggestion that saving your money in a traditional bank constitutes wise financial planning. I suggest that these kinds of assertions are part of a turf war between life insurance and that stock market and thus all such overgeneralized claims deserve careful scrutiny.
Choosing The Amount Of Life Insurance
Your need for life insurance will vary with your age and responsibilities. The amount of insurance you buy should depend on the standard of living you wish to assure for your dependents. You should consider the amount of assets and sources of continuing income available to your dependents when you pass away. Simply stated, you should choose an amount of life insurance that is determined necessary to meet the needs you are trying to satisfy.; A balance needs to be achieved in this process.; To be over-insured can negatively affect your budget and threaten your long range financial goals just as much as being under-insured can. While each person must individually assess their responsibilities, needs, and financial situation, it is important to be careful to choose an amount of life insurance that reflects your specific circumstances without under-insuring or over-insuring.
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Withdraw Funds From Cash Value
Its also possible to take withdrawals from your policy. If the amount you withdraw includes investment gains, often referred to as the part above basis, that portion is taxable. As with taking a policy loan, making a withdrawal will reduce the life insurance payout to your beneficiaries later on.
Continue Adding To Your Retirement Fund
There are pros and cons to both options but we would typically recommend maxing out contributions to retirement accounts prior to investing in variable life insurance.
With a 401 or IRA, your money will grow tax-deferred and youll have a wider variety of investment options with lower fees. The only downside is that it will be harder to access your money for a period of time, but even variable life insurance policies have surrender and withdrawal fees.
Assuming your retirement accounts are fully funded, then whether to put your money in a brokerage account or variable life insurance policy is dependent on how you believe the investment options of the variable policy will perform. Tax-deferred growth can counteract moderate management fees if your cash value performs well enough, but you need to evaluate expected performance for yourself.
Editorial Note: The content of this article is based on the authors opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.
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Key Risks Of Your Variable Life Insurance Policy
- Not a short-term savings vehicle. A variable life insurance policy is designed to provide a death benefit or to help meet other long-term financial objectives.
- Policy lapse. If you do not maintain sufficient cash value to pay your policy fees and expenses, your policy may lapse. That means it will terminate without value and your beneficiary will not receive any death benefit. A significant number of life insurance policies lapse.
Example: If your policy has a current value of $40,000 and fees and expenses that are $10,000 per year , your policy may lapse within four years. This could occur sooner due to poor investment performance or if you make a withdrawal or take a policy loan. Positive investment performance and paying additional premiums can reduce the risk of lapse.
Policy Dividends Used To Purchase Paid
Although policy dividends are not guaranteed, using available dividends to purchase paid-up additions can, over time, have a significant, positive impact on both the death benefit and cash value of a whole life policy. The diagram illustrates how this might work, in a hypothetical life insurance policy.
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When Is Cash Value Life Insurance A Good Idea
Cash value life insurance can be a wise investment if you can afford the higher premiums.
However, one school of thought argues that it’s better to “buy term and invest the rest.” This avenue means you’d take advantage of the lower premium term life insurance offers for a set period of coverage . Youd then invest the cost savings in the stock market.
The comparison chart below uses a New York Life Insurance Co. policy to demonstrate the potential financial returns you could reap if you took this approach. This comparison comes courtesy of James Hunt, a retired actuary with the Consumer Federation of America and former insurance commissioner of Vermont. His analysis estimates the “real” interest rate earned on savings within a cash value policy.
What Is Variable Life Insurance
Variable life insurance is a type of permanent life insurance policy., meaning coverage will remain in place for your lifetime so long as premiums are paid.
Every variable life insurance policy has three primary components:
- Death benefit
- Cash value
A death benefit is what is left to your beneficiaries. Every time you make a premium payment, a portion of it goes towards the cost of insurance and insurers fees, which keep the death benefit in place. The remainder of the premium goes towards the policys cash value, which is similar in structure to a brokerage account. The cash value can be invested in certain securities which resemble mutual funds.
If the cash value performs well, it can be used to increase the death benefit, withdrawn as cash or used as collateral for a loan.
The cash value is also the amount of money you would receive if you decided to give up your coverage to the insurer, or surrender it.
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Example Of Cash Value Vs Surrender Value
Suppose you purchase a whole life insurance policy with a death benefit of $200,000. After 10 years of making consistent, on-time payments, there is $10,000 of cash value in the policy. You consult your insurance contract and see that the surrender charge after 10 years is equal to 35%.
This fee means if you tried to cancel your policy after 10 years and withdraw your cash value, the insurance provider will assess a $3,500 charge to your cash value, leaving you with a surrender value of $6,500.
Using Cash Value To Pay The Premiums
If you build up enough money in your cash value account, you may be able to use your cash value to cover premium payments, depending on the policy. If youre struggling to make the payments, this option could provide some relief so that you can keep the life insurance in force.
If you drain all the cash value from the account, the policy could lapse, so be aware of your cash value level.
Talk with your insurance company to find out their rules for using cash value toward your premiums.
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How Variable Life Insurance Works: Pros And Cons Of A Variable Policy
Variable life insurance, also called variable appreciable life insurance, provides lifelong coverage as well as a cash value account.
Variable life insurance policies have higher upside potential of earning cash than other permanent life insurance policies. With variable life insurance, you get to decide how to invest the cash value. However, variable life insurance policies often come with higher fees than other cash value life insurance policies.
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Total Disability Benefit Rider
This rider will waive my payments to the life insurance company; if I become totally and permanently disabled due to sickness or accident.
If I am disabled, I cannot work already and may not earn money so this rider will protect me from not being able to pay my premium due to total disability.
Although this rider is again optional, I added it because I believe it is; very important. Actually, I consider this a MUST have rider for every life insurance policy.
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Difference Between Cash Value And Face Value In Life Insurance
May 14, 2021
If you have a permanent life insurance policy, there are two terms that you should familiarize yourself with: cash value and face value.
As the name suggests, a permanent life insurance policy offers permanent coverage because it offers coverage for the entire span of your life, rather than just a specific amount of time, like term life insurance. Whole life and universal life are two types of permanent life insurance policies.
Cash value and face value are features of a permanent life insurance policy. Both of these terms refer to the benefits that your life insurance policy offers, the meaning of these terms are very different; not only are they different to you, but they are also different to your beneficiaries.
Can I Take The Cash Value Of My Life Insurance
You can withdraw money or take a loan against your cash value and use the money for anything you like. If you decide to terminate the policy, you can take the cash value .
Keep in mind, if you withdraw money from the cash value and the amount you withdraw includes interest or investment gains , you will be taxed on that portion of the withdrawal.
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Types Of Life Insurance Policies
For the most part, there are two types of life insurance plans – either term or permanent plans or some combination of the two. Life insurers offer various forms of term plans and traditional life policies as well as “interest sensitive” products which have become more prevalent since the 1980’s . In New York State, the Department of Financial Services must approve any life insurance policy before a company can issue it to consumers and New York Insurance Law provides for standard provisions that must be included in every policy.
Put Up Cash Value As Collateral To Borrow From Your Insurer
A life insurance policy loan is a loan from the insurer in which the cash value of your policy is used as collateral. It can be used for paying medical expenses, buying a car or anything else you might need cash for. Since the insurer holds the funds to cover the loan:
- There are no underwriting requirements
- You can keep the loan outstanding for as long as you want
- Theres no credit check, and the loan doesnt appear on your credit report
However, if you pass away while the loan is outstanding, the value of the loan will be deducted from the death benefit your beneficiaries receive.
Borrowing against your policys cash value is simple and typically comes with quite low annual interest rates. But you need to either pay interest out of pocket annually or carefully monitor the size of the loan as compared to the policys cash value.
If you dont make interest payments, the interest amount is added to the outstanding loan balance. If the total size of your loan ever exceeds your policys cash value, the life insurance policy will lapse, canceling your coverage. In addition, you will likely have to pay income tax on the loan.
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Is Whole Life Insurance Worth It
Whole life insurance is worth buying for many people. While its typically more expensive than term life insurance, as long as your premiums are paid, it offers permanent coverage with premiums that never change regardless of your health or age. It also builds cash value over time, giving you the opportunity to take out a loan from your policy to pay for medical bills or other expenses.
What Are Cost Of Insurance Charges
The Cost Of Insurance charge is the main expense that is deducted from a universal life policy each year to compensate the insurance company for the actual risk of needing to pay a death benefit if the insured dies. Other expenses charged by insurance companies include premium loads, monthly policy charges, and surrender charges, which will be discussed later in this article.
There are two main components to this Cost of Insurance charge: the Cost of Insurance rate , and the Net Amount at Risk .
The Cost of Insurance rate accounts for the risk that the insured dies in any given year, such that the insurance company would have to pay the death benefit. Not surprisingly, the COI rate increases each year as the insured gets older and has a higher chance of dying with age.
The Net Amount at Risk reflects the amount of actual dollars at risk for the insurance company if a death benefit does need to be paid. Since the insurance company already has a certain amount of cash value on hand associated with the policy , the insurers true amount at risk is only the difference between the death benefit, and the amount of cash value that has already accumulated.
Accordingly, the full charge for the cost of insurance is a combination of the COI rate for a potential amount at risk , multiplied by the actual Net Amount at Risk that the insurance company is providing coverage for, as summarized by the following formula and the two following graphs:
Cost of Insurance Charge for Year = *
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What Is The Difference Between Whole Life Insurance And Universal Life Insurance
The key difference between whole life insurance and universal life insurance is that universal life insurance can have more flexibility. You can often vary your premium payments and death benefit with universal life. Whole life insurance has set premium payments.
But both types of policies have cash value, and you can add riders to either one.
What Happens To Whole Life Insurance At Age 100
Many whole life insurance policies are written to expire at age 100. But if you live longer than that, you have a couple of options. For instance, if you are younger than 85, you could do a 1035 exchange into a new policy that lasts until age 121. And if youre in your 90s, you may be able to do a 1035 exchange into a deferred annuity with the cash value of your policy. But before you do anything, you should talk to your financial planner and insurance agent to help you make the best decision.