Life insurance is an important part of a comprehensive financial plan. Here are 7 things you should know about it.
At its simplest, you probably already know that life insurance provides funds in the case of unexpected loss of life. But there may be other aspects of life insurance that are less clear to you. If there are things about life insurance that you don’t understand, you are not alone! In fact, from research conducted by LIMRA in 2019, American consumers answered “don’t know” to 40% of the questions on a life insurance knowledge test, and if they did answer, they were correct less than half the time (46%).
Not to worry. It’s September, which means it’s Life Insurance Awareness month, and we’re here to clear up some of the basics about life insurance.
1) Policy Beneficiaries Receive Payouts
The beneficiary or beneficiaries named on a life insurance policy are the ones who receive the payout from the insurance company that issues a life insurance policy. Often a spouse, child, or other loved ones are named as beneficiaries, but in some cases, the beneficiary of a life insurance policy might be a trust.
NOTE: It is very important that a policy owner keeps policy beneficiaries up to date as situations, ages, and relationships change through time. An annual review is recommended.
2) A Life Policy Is “Written On” a Named Insured or Insured Persons, Not Always the Policy Owner
A “named insured” on a life policy is the one whose life is being insured. Generally, an insured person will purchase a policy on themselves, naming themselves as the insured, so that when they die, the death benefit goes to their chosen beneficiaries.
But an owner is not always the same as the insured. As an owner, you control the policy, and you can purchase a life insurance policy on someone else, as long as you would suffer from their death as a family member, business partner, or some other close relationship.
For instance, sometimes spouses will purchase policies naming each of them as joint insureds. These can be set up as “first to die,” where the surviving spouse or other named beneficiary receives the death benefit as soon as the first spouse dies, or as “second to die” (sometimes called “survivorship”) policies that only kick in to pay beneficiaries after both insureds have passed away.
In some cases, you might want to purchase a policy but make someone else the owner, for example, as a strategy inside a trust.
Or sometimes a parent or grandparent will purchase a policy naming a child or toddler as the insured. Naming the child when they are young and healthy (while the cost of insurance is low) can be done as a strategy to help save for the child’s future college expenses, and to ensure that the child has life insurance in place should they develop a health condition later.
3) Life Insurance Usually Requires Medical Underwriting
Life insurance usually requires medical underwriting, which means that once you apply for a life insurance policy, the insured person’s lifestyle, height and weight, medical history, and general level of health will be assessed (and approved) before your policy will be issued. Sometimes a physical exam will be required, and sometimes life insurance coverage will be denied, for example, if the insured person has a terminal condition. But even if you are in poor health, you may be able to obtain a life insurance policy at a higher cost.
And you may be able to purchase life insurance even if you are age 70 or older. In fact, more people are doing so because the estate tax exemption amount is set to drop to around half the amount it is now in the 2026 tax year, and consumers are seeking tax advantaged strategies to pass on wealth to their heirs.
4) Premiums Are What You Pay for Insurance
The word “premium” in the context of a life insurance policy is how much you will pay monthly, annually, or once for single premium life insurance policies. Premiums are determined on an individual policy basis based on many factors, including age, health, and credit.
5) Most Life Insurance Payouts—aka Death Benefits—Are Tax-Free and Probate Free
The money paid by an insurance company to a beneficiary upon the death of the insured person is called a “death benefit.” In most cases, a death benefit is tax-free and bypasses the probate process unless it’s paid to a trust, in which case different IRS rules may apply.
This can be a tremendous help to the spouse and family members during their time of grief and beyond as they look to their futures. It’s often recommended that a life insurance policy’s death benefit be in an amount that can cover monthly living expenses, mortgage payments, future college expenses, etc., protecting families from immediate and future economic devastation.
6) Life Insurance Can Be Used for Estate Planning Trusts and Business Succession Plans
It’s important when setting up complex estate plans, trusts, and business succession plans which may include life insurance that you consult with a team comprised of your financial advisor, estate attorney and CPA/tax professionals. IRS rules and tax laws are always in flux.
For instance, a recent Supreme Court ruling may change the tax ramifications of business buy-sell agreements. Be sure to meet with your team of advisors to review.
7) There Are Many Types of Life Insurance
In addition to term life policies, there are many permanent life insurance policies, including whole life, universal life and variable life. While a death benefit is always part of a life insurance policy, different types of life insurance policies are structured differently, and may contain additional features as part of the structure of the policy itself, or available as a “rider” to the policy for an additional premium amount. For instance, some policies even offer coverage for long-term care should you develop the need for it but provide a death benefit for your heirs if you don’t.
Life insurance is complex, and a life insurance policy is a contract between you and an insurance company. It is recommended that you work with your team of advisors to examine each contract clause thoroughly before purchasing a life insurance policy.
8) Permanent Policies with Cash Value at Wealth Sync Partners
At Wealth Sync Partners, we treat the cash value component of life insurance (and annuities) as an asset in the overall asset-allocation plan. Our philosophy is that the cash value should be considered a portion of the bond allocation in a client’s portfolio. And for clients with a 60/40 portfolio, we may sometimes discuss whether or not it makes sense to have a portion of that 40% in insurance-based instruments that provide “risk pooling” using actuarial credits to enhance your overall investment strategy.
The cash value in insurance or annuity policies can augment the distribution of your retirement assets because of its nature as an ever-increasing instrument per contract terms, particularly whole life with dividends. We think of the cash value as being a market buffer when volatility spikes in the investment markets.
Lastly, the cash value can be accessible with some types of life policies, meaning cash can be withdrawn or borrowed by the policyholder for any reason as a tax-free loan, potentially making the cash value a useful source of income for retirement, postsecondary education, a downpayment for a home, or any other major expense. While borrowing from the cash value of a policy does accrue interest per policy terms, the cash value continues to be credited interest as if the borrowed amount is still there. That gives the cash value a chance to keep pace with, or even outpace, the amount the policyholder owes in interest.
And importantly, if the policyholder uses the cash value as a tax-free source of retirement income and never pays it back, the borrowed amount plus interest is simply taken from the death benefit. It’s important to read and follow the contract terms carefully to make sure that the policy stays in force whenever the cash value is borrowed.
If you would like to discuss life insurance, please contact us! You can set up a wealth alignment call with Wealth Sync Partners by clicking here.
This document is for general information purposes only and is not to be relied upon for financial advice. In every case, you should seek the advice of qualified tax, financial and legal professionals to ensure that a life policy is advisable based on your unique circumstances.
Life insurance often requires medical underwriting. Guarantees are provided by insurance companies and are reliant upon the financial strength and claims-paying ability of each individual insurance carrier issuing a life insurance contract.
Sources:
https://www.thinkadvisor.com/2024/08/26/u-s-life-application-activity-soars/
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