Saturday, November 10, 2007

The Life Insurance Debate

If you are in the market for life insurance, there are so many choices. Most people and financial experts do not understand the multiple uses of life insurance, and there is gross misunderstanding in the marketplace. Let's explore the types of insurance contracts.
Term Insurance
Term is pure death benefit. It covers a insured for a finite period of time:10,15,20,or 30 years. The premiums are fixed during the term period. If the insured dies during the term, the insurance company pays the death benefit to the beneficiary. If you live beyond the term, the policyholder in some cases is allowed to keep the policy, but the premiums increase based on the policyholder's age at the end of the term. In other words, your premium will be more expensive! Most "experts" believe in using term because it allows the client to have coverage while building up his/her 401(k)/IRA plans. Usually in this case, the goal is to build up the liquid asset base so the need of Term insurance is reduced or eliminated at the end of the term. The policyholder would be "self Insured" at that point.
Whole Life
Whole Life or Permanent Life provides Death Benefit and Cash Accumulation. The coverage will last the "whole" life of the insured. The premium payments are fixed for the "whole" life of the insured. When the Insured Dies, the beneficiary receives either the death benefit or cash value. The policy owner can withdrawal cash from the accumulation account while the policy is active. The cash account will receive interest earned based on the type of whole life policy. The insurance company will invest money and place some of the returns back into the policyholder's account. He/She can loan against the cash and pay it back. Many people use Whole life insurance for multiple uses: Death Benefit, Cash Accumulation, Wealth Transfer, etc. There are variations of whole life, such as Variable, Fixed, 20 pay, etc. Since Whole life is more expensive than the term insurance, the death benefit is lower based upon the cost of the insurance.
Universal Life
Universal Life was a brain child of EF Hutton back in the 1980s. It is a flexible insurance contract. It has the features of Term and the features of Whole Life Insurance. The policyholder can CHOOSE his/her payment. The policyholder can pay the minimum payment to keep the "term" insurance in force, or pay more into the cash accumulation account. There are different types of Universal: Fixed, Variable, Equity Indexed. These types just describe the type of accumulation account. Fixed is based on the returns from the Insurance companies' conservative investment portfolio. They will have a guaranteed floor and low maximum rate of return. The cost to run this type of UL is low. The next type of UL is a Variable. This was the answer of AL Williams crusade of "Buy Term and Invest the Difference". The VUL is term insurance with a sub account that gives the policyholder choice of various equity investment products(mutual funds). The gains in the sub account can grow tax free or tax deferred similar to a Roth IRA! This is an excellent product for someone who wants aggressive tax free growth! It has a high expense charge to maintain. Equity Indexed is a mix between a VUL and a Fixed UL. It allows some of all of the cash account to grow based on an external indicator such as the S&P 500 index. It provides the policyholder the ability to grow with the index, but not lose the principle when the index goes down! The expense to run a EIUL is between the Fixed and Variable UL.
With UL policies, the policyholder can use them to save for retirement. Here is why; due to the various laws in the tax code, insurance contracts can be structured to accumulate wealth TAX FREE! Death Benefits are not taxable in most cases! The accumulation account can be accessed TAX FREE with a loan without reducing the principle! That is powerful!
Critics of Universal Life
Critics of Universal Life have stated the upfront loads are expensive. If you had a World Class Race Horse would you feed to left over hay? The UL is a Race Horse if set up properly! The UL contract is the most efficient way to accumulate wealth and transfer wealth TAX FREE. Since various Laws and Tax codes have to be satisfied in the UL contract, the first several years will be front loaded. When purchasing a UL contract; only work with a professional that REALLY understands how these contracts function. Many have been sold a UL policy and have NO clue of the POWER of the contract; thus the critics of the contract. The loudest critics really have not researched these contracts either.
I personally think the the UL contract is an excellent tool to save for retirement, and you get the death benefit as an added benefit! You can use the Life insurance while you are alive! If you are younger, the VUL and EIUL are excellent options, and older people concerned about principle may look at a fixed UL or certain types of EIULs. The UL may not be for everybody or every situation. In some cases, the VUL/EIUL can out pace the "buy term and invest the difference" strategy due to the benefits of the life insurance contract. Why over fund a 401k/IRA when you will be taxed at 59 1/2 or at retirement? If most people think taxes will be higher, why accumulate all this money for the IRS to take away? That is the "buy term invest the difference" campaign. With the VUL/EIUL wealth building strategy, you can buy term invest the difference in the insurance contract; AND transfer the wealth TAX FREE!
We have to build a financial ark. They are many tools to assist us in the process. Life Insurance can be used as a tool to build the ark. Don't close off all the tools in the tool box, when you don't understand how the tools work. Do your homework and research on how the contracts work. Don't listen to the critics or so called "experts" check the Internet and find out the truth. One Trick ponies don't work when there are multiple ways in building an ark.