Life insurance is a contract between a policyholder and an insurance company that insures the risk of an insured’s premature death. In exchange for the protection of a specified death benefit (also known as the face amount), the policyholder agrees to pay a premium typically on a monthly or annual basis. The amount of premium paid is determined by a the classification of the insured’s health upon application. The factors that an insurance company considers when classifying an insured health include age, personal and family medical history, and the current lifestyle of the insured. By pooling similar risk classes and charging various premium rates, the insurance company can provide affordable coverage to those who are unlikely to need the coverage, and charge higher rates to those who will.
Living Benefits of Life Insurance
Often referred to as an accelerated death benefit (ADB), these are riders can be attached to a life insurance policy that allow the policyholder to receive a certain percentage of the death benefit as an advance if the insured becomes critically, chronically, or terminally ill. In many cases, these riders can be used to fund special care such as advanced treatment, assisted living, or a nursing home facility. These insurance benefits can be critical in the protection of an individual’s medical and financial health in the case of serious injury or illness. Many of the insurance companies that are represented through Sentinel Financial Advisors offer insurance policies with these riders, helping to protect our clients when they need it most. In cases where an existing policy is held without these benefits, there may be other options that our advisors can assist you with.
Term Life Insurance
Term life insurance, also known as “pure insurance”, provides life insurance coverage for a specified length of time. Common term periods are one year with a guaranteed renewal (at a higher premium) up to a certain age (typically 95-100), or level premium for periods of 5, 10, 15, 20, 25, or 30 years. The insurance covers the death, or in some cases illness or injury, of an insured during the specified time period defined by the insurance contract at issue. Often more cost efficient than permanent insurance, this type of life insurance is appropriate for situations where there is a need for insurance, but not as much free monthly cash flow to fund a permanent policy.
Universal Life Insurance
A form of permanent life insurance, universal life insurance combines that cost-efficiency of term-insurance with the lifetime insurance coverage of whole-life insurance. These types of policies can be designed to have a cash-savings component, accruing interest based on mechanisms such as variable investments, fixed interest rates, or interest based on equity indices. Once significant cash value has been accumulated, these funds can typically be used on a tax-free basis to fund retirement or other savings goals.
Alternatively, if the policyholder desires to further reduce the policy’s premium by not have a savings component, there are policies which provide such coverage. These policies are known as Guaranteed Universal Life (GUL), and can be advantageous because premiums and coverage are guaranteed by the terms of the insurance contract at issue. These types of universal life insurance policies focus on guaranteed rates, removing moving cost and interest accumulation components found in other cash-value life insurance policies.
Premium Financing of Life Insurance
In short, premium financing is the borrowing of funds from a bank or other lending institution to fund the premiums of a cash-value or term life insurance policy. Typically only suited for high-net worth individuals, this strategy can allow the policyholder to only pay the interest on the loans financing the premiums, rather than paying the actual insurance premiums directly. Upon death, the remaining balance on the loans used to finance the premiums will be paid back to the lending institution from the death benefit, and the remaining benefit is received by the beneficiaries of the policy. This strategy is especially well suited from an individual expecting to pay significant estate taxes, as the proceeds of the insurance death benefit can offset these taxes at death.
Tax Advantages of Life Insurance
According to the Internal Revenue Service Code Section 7702, death benefit proceeds from life insurance contracts are to gifted to beneficiaries without taxation, nor reportable as taxable income to beneficiaries. However these circumstances may change if the estate of the deceased exceeds a specified amount.
While providing a tax free benefit, life insurance contracts may also present a tax-advantage in their tax-deferred accumulation, non-taxable dividends, or withdrawal of funds through tax-free policy loans.One of the more unique aspects of permanent insurance, life insurance policy loans allow the policyholder to withdraw funds from the life insurance contract as a non-taxable loan against the death benefit. While these loans can be used to finance retirement or savings goals, the cash-value within the permanent life insurance contract remains, accumulating additional interest within the policy. These loans often do not need to be repaid, as they will be recaptured by the insurance company at the time of the insured’s death. However, it is important to consider factors such as policy loan interest rates, as these high rates can have a significant impact on the remaining benefit of the policy.