Life insurance 101: Options and considerations
Money Matters
By David B. Snyder, JD, CLU, September 2, 2019
Life insurance is typically part of every dermatologist’s financial plan, at least for those with dependents. Despite its common usage, many physicians, including dermatologists, do not really understand how life insurance products work — especially permanent life insurance, also called “cash value” insurance. The initial segment of this two-part article presents an overview of the different types of life insurance products and the pros and cons of each. In the next installment, I will focus on the more complex permanent life insurance and discuss the success factors to look for when evaluating and implementing such products.
Types of life insurance products
Term life insurance
Term life insurance policies offer pure death benefit protection. Premiums must be paid by the policy owner and the death benefit is paid by the insurance company to the beneficiary if the insured dies within the term of the policy. Those are the only financial elements of term life insurance.
Term products carry no cash value and provide protection for a limited period of time (referred to as a term). This limited time frame is usually 10-20 years, though some companies offer a 30-year term product. A term life insurance policy pays a specific lump sum to your designated beneficiary upon your death. As such, it can play an important role in providing temporary death benefit protection for your family (or practice/partners as part of a buy-sell arrangement).
Pros: Term life insurance provides affordable coverage that pays only a death benefit. Term life insurance initially tends to cost less than other insurance policies because it has no cash value.
Cons: Term life insurance premiums increase with age because the risk of death increases as people get older. Some term premiums may rise each year, or after 10, 20, or 30 years. Over the age of 65, the cost of a new term insurance policy may become very expensive, often unaffordable, and term insurance is not available beyond a certain age. It is not a good tool for estate planning because the coverage cannot be continued at a reasonable price as you approach life expectancy.
Permanent life insurance
Permanent life insurance products are those that, unlike term, carry cash value along with death benefits and can last for the entirety of the insured’s life, even to age 100, 115, and beyond (i.e., they are “permanent” as long as the required premiums are paid on time).
Permanent life insurance has many different types, but they all have some common characteristics. They all have a cash value that grows based on some type of underlying investment. That growth is tax free, and, if properly structured the cash value can be accessed tax free. The death benefit is also tax free to the beneficiary.
Within the general category of “permanent insurance,” there are a host of different products. Many refer to all permanent products as “whole life,” but as you will see below, whole life is only one type of a permanent policy. Let’s look at how permanent life insurance products differ from each other.
1. Whole life insurance
Whole life (WL) insurance pays a death benefit to the named beneficiary and offers you a cash value account with tax-deferred cash accumulation. Many physicians are “pitched” whole life by captive insurance agents for companies whose central product is whole life. This may be why many dermatologists think of the entire category of permanent insurance as “whole life.”
Pros: WL insurance has a savings element (cash value), which grows tax deferred. The cash value grows based on the life insurance company paying a dividend. This dividend is determined by the life insurance company, is not guaranteed, and can/will change annually.
If properly structured, you can borrow from the cash value tax free. WL has a fixed premium which can’t increase during your lifetime (as long as you pay the planned amount on time), and your premium is invested for you long term.
Cons: First, due to the low interest rate environment during the last 15 years, dividend rates on WL policies have been decreasing. Second, WL insurance does not allow you to invest in separate accounts (i.e., money market, stock, and bond funds). Thus, your policy’s returns will be tied to the life insurance company’s dividend credit based on that insurance company’s underlying investments. A WL policy also does not provide premium flexibility or face amount (the amount of death benefit) flexibility, and the policy holder is not able to allocate money among different investment accounts or move money between accounts.
2. Universal life insurance
Universal life (UL) insurance is similar to whole life insurance yet has more flexible premiums.
Pros: The cash value in a UL policy grows based on interest crediting to the policy at a rate determined by the insurance company. UL may be attractive to younger buyers who may have fluctuations in their ability to pay premiums.
Cons: If the insurance company’s investments perform poorly, the interest return on the cash portion of the policy could decrease. In this case, less money would be available to pay the cost of insurance charges for the death benefit of the policy and future premiums may be necessary in addition to the premiums originally illustrated. Additionally, the cash value will grow slower than originally illustrated and there will be less money to borrow during distribution years.
3. Equity-indexed universal life insurance
Equity-indexed universal life (EIUL) insurance is a universal policy that allows you to select from a list of stock market indices to grow your cash value. Typically, there is a guaranteed minimum death benefit paid to your beneficiary upon your death.
EIUL can give you more upside than a traditional UL policy because the insurance company contractually agrees to credit the policy’s cash value with the same return as the stock market index the policy holder chooses (typically, the S&P 500 Index, but the Dow Jones, NASDAQ, EAFE, and Euro Stoxx are other options) realized over the same period of time — subject to a cap and a floor. Thus, the policy owner has the upside of the indices to the cap, but the risk of the same indices to the floor. Typical floors for an annual return range from around 0% (no loss of principal), with caps around 10%.
Pros: EIUL enables you to get potentially more upside in the cash value accounts than in whole life but also provides you with downside protection.
Cons: Products are relatively complex, with many choices of indices, participation rates, floors and caps, and they vary significantly among insurance carriers. Working with a professional that can help you make good decisions upon policy placement and provide annual management is essential.
Conclusion
While term life insurance is a fairly simple financial product, permanent life insurance, in all of its forms, is not. Nevertheless, permanent life insurance may be quite beneficial for many dermatologists. In the second part of this article, I will discuss permanent insurance in more depth, including a few important success factors that should be part of any allocation of assets to permanent life insurance.
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This article contains general information that is not suitable for everyone. The information contained herein should not be construed as personalized legal or tax advice. There is no guarantee that the views and opinions expressed in this article will be appropriate for your particular circumstances. Tax law changes frequently, accordingly information presented herein is subject to change without notice. You should seek professional tax and legal advice before implementing any strategy discussed herein.
