Buying Guidelines for Life Insurance

Published February 22, 2013 / FOXBusiness

Life insurance may be a great tool for your retirement portfolio by providing  protection for a family member or someone else when something happens to you,  but navigating the industry and finding the right plan can be tough.

There are different kinds of policies and coverage amounts and when  considering a policy, experts suggest making sure the policy fits your financial  goals.

Life insurance can replace income, pay debts and provide liquidity and some  experts argue that having a policy makes sense with rising tax rates.

“Life insurance isn’t for everybody and it depends on your situation,” says  chartered financial analyst Robert Stammers, director of Investor Education for  the CFA Institute. “If you don’t need to defer a lot of your compensation or  you’re limited on your tax benefits from retirement plans, insurance can fill  that void.”

There are two basic types of policies: term and permanent life insurance, and  experts say the right choice depends on your financial situation.

Term insurance is very straightforward—the policyholder pays monthly or  annual premiums and a lump sum is paid to beneficiaries when the policyholder  dies. “You buy life insurance when you have a need for that death benefit,” says  Joseph Montanaro, certified financial planner at USAA.

Permanent policies are more complicated and tend to be more expensive. These  have the same death benefit as term insurance, as well as a cash value that  accumulates tax-deferred. Policyholders can take a loan against this cash value  that reduces the death benefit if unpaid. Different types of permanent policies  (whole life, variable universal life or universal life) have flexibility in  premiums and coverage, annual tax-free dividends, or the ability to direct how  the cash value is invested.

Once you build the cash value in your policy, you can draw it down anytime  during your life—take your basis first and then switch to a loan, according to  Michael Bonevento, private wealth advisor at Ameriprise Financial.

Premiums for permanent polices can be four to five times higher than term  policies, says Montanaro. With a permanent policy, you’re paying for that cash  value and the ability to take money out of your policy tax-free. The catch is  that you have to stay current on your premiums since if the policy lapses,  you’ll likely owe taxes on this money.

Premiums for a 45- to 50-year old nonsmoking man in good health can range  between $50 and $100 per month for a $500,000 term policy, for example, while a  $500,000 permanent policy can cost about $600 per month. Depending on the  interest rate earned through the policy, the cash value can potentially reach  about $35,000 in five years (almost the amount paid in premiums during this  time) and accrue to about $190,000 in 20 years.

“If you stop paying premiums on a permanent policy, the premium will be  deducted from the cash value and if you terminate the policy, you get that  cash,” says Montanaro.

Since there are many different options, people need to be very selective in  what they buy, warns Stammers. “If they have an advisor, they should go through  their advisor to make sure it fits in their plan. There are load fees and admin  fees in life insurance and when you look at the return, it could be  significantly less than if they put the money in a mutual fund.” Experts suggest  asking questions before buying a policy.

Why buy life insurance if you’re young?



A universal or whole life insurance policy can work well for younger people  who aren’t disciplined about saving—the policy forces them to put money away,  says Stammers. “By the time they’re 50, they’ll have saved a significant amount  but they may have been better off if they invested on their own. They’ve created  a liability that needs to be funded—if you stop paying your premiums, you can  lose some or all of the cash value depending on what your policy says.”

What are the tax benefits?



Before committing, experts suggest comparing the policies to other investment  opportunities.

“There are a lot more ways to save for retirement and a lot of choices from a  tax standpoint that you’d want to max out before considering life insurance as a  retirement investment,” says Montanaro. He says Roth and traditional IRAs and  employer plans, as well as money saved outside of retirement would be  alternatives.

If you don’t benefit for a Roth IRA because your income is too high, a  universal life policy may be a good option, says Stammers. Once you stop paying  into the cash value, the cash value will pay the premiums for the term portion  of the insurance and you can defer the capital so that your estate pays the  taxes.

Experts suggest diversifying your tax planning since tax laws can change  frequently. “You want to try to defer as much compensation as possible,” says  Stammers. “Considering the fees, the ability to grow money tax-deferred is  really the value in insurance as an investment.”

Do you need guaranteed income?



“If you pay enough money into the [permanent] policy to accumulate a  meaningful cash value, when you retire, you can take payments that draw down the  cash value over whatever period you want,” says Bonevento. You won’t owe taxes  on this money as long as you continue paying premiums and the cash value isn’t  zero.

If you’re looking for a guaranteed investment, Montanaro suggests considering  a fixed annuity instead of insurance. Both earn interest but insurance policies  are more expensive, says Montanaro. “If for some reason you don’t need that  death benefit, there may not be a compelling reason to include insurance in your  portfolio.”

Consider when you want to access that money. “You can’t touch annuities until  you’re 59.5,” says Bonevento. According to the Internal Revenue Service, there’s  a 10% penalty for withdrawing money from an annuity before age 59.5. Regardless  of when you withdraw money, you have to withdraw the gain first, which is  taxable.

Will you need to replace lost Social Security Benefits and  pensions?



Life insurance can provide protection against economic loss. If you lose your  spouse’s Social Security benefits or pension when he or she passes, life  insurance can help you make up for that loss in income, says Montanaro. “Social  Security has no mechanism to buy a survivor benefit,  and most pensions have a survivor option but it’s going to be a lesser amount.  Think about your spouse’s security if they were to lose that benefit.”

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