Maryland Bar Bulletin
Publications : Bar Bulletin : July 2006

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Life Insurance: One Size Does Not Fit All

In its simplest form, life insurance helps protect your beneficiaries against economic loss caused by premature death. The proceeds go to them free and clear – generally exempt from federal income tax. However, there is much more to life insurance. There are a variety of different types of life insurance, and each type has its own unique features and benefits. With this product, one size doesn't fit all, and, like tailoring a suit or fitting a golf club, finding the right fit takes knowledge and analysis.

Most consumers have heard of term life insurance and permanent life insurance; what most do not know is how many variations of each there are. Examples of term life insurance include level premium term, yearly renewable term and decreasing term. Permanent life insurance includes whole life, universal life, variable life and variable universal life to name a few. A good understanding of each life product will allow you to make an appropriate decision on what type or types of life insurance might be most beneficial to you at each stage of your life or your business' growth.

A Versatile Tool

Life insurance can be a versatile tool to address many needs within a broad financial or business plan. Its many uses can include:

For you and your family:

  • Providing your dependents with cash for expenses and debts and a replacement of income
  • Conserving your estate and providing cash to pay estate taxes
  • Enabling you to equalize inheritances among your family members
  • Leaving a legacy to your favorite charities
  • Creating a fund to supplement your retirement resources
  • Helping to assure your children's college education is funded in the event of your early death

For your business and your employees:

  • Funding attractive benefit plans that encourage long-term employment (these may include non-qualified Deferred Compensation plans, executive bonus plans, split-dollar insurance plans that share the cost with the employee, and Supplemental Employee Retirement Plans [SERPs]).
  • Funding a plan to help ensure your business will continue after the death of a principal.

Term Life Insurance

Term life insurance is the most basic type of life insurance, providing a death benefit only if death occurs within the specified term of the policy. There is usually no cash value or savings component to the contract and premiums may be renewable at varying rates on a yearly (or longer) basis or may be level for the length of the policy. Contracts are typically offered for a period or term of five, 10, 15, 20 or 30 years, or on an annual renewable basis.

Generally, term life offers the most death benefit protection for the lowest cost. It is often used for defined protection needs, when there is a limited cash flow, or if temporary protection, for a known duration or a specific purpose, requires a substantial amount of insurance coverage and costs must be kept at a minimum. These circumstances might include covering: the term of a mortgage, dependent children to a specific age or large, temporary business obligations, loans, etc.

Whole Life or Permanent Insurance

Whole life insurance is a form of permanent life insurance. The appeal of whole life is twofold: it assures a minimum death benefit, no matter how long you live, as long as premiums are paid and those premiums are fixed and certain to remain the same for the life of the insured. What is more, the premiums you pay contribute to building a guaranteed minimum cash value, which can be used in several ways. It can be borrowed against or withdrawn. If you decide to close out the policy, for whatever reason, you can take the accumulated cash or use it to purchase other insurance protection. If left untouched, the cash value increases each year until it "endows" or becomes payable to you. Whole life insurance is a good choice if you are looking to accumulate savings to create a "living benefit" and if you absolutely want to have life insurance in effect at your death, no matter when that occurs – in 10, 20 or even 50 years.

Universal Life Insurance

Another form of permanent life insurance is universal life. It usually costs less, initially, and offers more flexibility than whole life but has fewer guarantees. It allows you to determine the amount and timing of premium payments within certain limits in contrast to whole life insurance, with its unchanging, regular premium payments. In fact, if cash values are sufficient to cover premiums in a universal life policy, you may actually skip premium payments, without penalty.

Universal life offers minimal investment risk, with a lower initial premium and considerably more policy flexibility than whole life. It is especially attractive in terms of cost for people whose life expectancy may be relatively short because of advanced age or deteriorating health. It may also be a good choice if the funds you have available for insurance vary significantly from year to year, due to cash-flow constraints.

Variable Life Insurance

Variable life insurance is an innovative insurance product that combines death benefit protection with investment opportunity. That means there is the potential for growth in your policy's cash values, and possibly in the death benefit, too. Variable universal life (VUL) is a viable option if you are willing to assume investment risk in exchange for potentially higher growth. As your personal or family estate grows, VUL's death benefit – if properly funded – may keep pace with inflation or escalating estate settlement costs better than that of whole life or universal life. In short, if you want the lowest potential cost, or the most flexibility over the long term – and have the necessary risk-tolerance – variable universal life may be the most suitable policy for you.

What Type of Insurance and How Much?

Now that we have identified several types of life insurance products and talked about how they are used, think about how to determine how much life insurance coverage is needed and what life product or combination of life products is most appropriate for someone's particular situation. We determine the type of product by outlining goals and objectives and the amount of coverage by completing what is commonly referred to as a "needs analysis".

First, a number of questions should be addressed: Is our life insurance coverage going to be used for individual family planning or for business planning? How much coverage is needed and for how long is the coverage needed? Are we looking to build savings or just looking for pure protection? What funds are available to be allocated to pay premiums for life insurance?

After these questions are addressed a needs analysis for life insurance should be completed. A needs analysis is a calculation based on your personal financial information and includes your family's needs to determine the appropriate amount of life insurance. There are a number of important factors to consider when determining how much life insurance protection you should have in force.

  • Any immediate needs at the time of death such as final medical expenses, burial costs and estate taxes
  • Funds to pay off outstanding debts, such as a mortgage, credit cards, car loans or any income taxes due
  • Ongoing financial needs such as monthly bills and expenses, day care costs, university tuitions and retirement income

Although life insurance can simply provide a death benefit to your beneficiaries upon your passing, it can also be a complex financial instrument used to accomplish diverse and multifaceted goals. Determining the most appropriate life product and the most appropriate amount of life insurance for an individual takes considerable thought, an outlining of goals and objectives and an analysis of the unique features of each life insurance product currently available in the marketplace. The appropriate life insurance product and design of coverage can help improve your overall financial security, ensuring your family and/or your business financial stability in case of your unexpected death.

Todd E. Binder, MBA, is an associate of FranklinMorris, Coordinating Broker for the Bar Associations Insurance Agency, Inc. For more information on the insurance benefits available to MSBA members, visit www.msba.org/departments/membership/baia/franklinmorris.pdf.

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Publications : Bar Bulletin: July 2006

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