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Life Insurance Alert

This life insurance alert recognizes that purchasing life insurance is an important commitment, but there can be confusion and too much wishful thinking that distorts the process. To make it worse, some life insurance companies have improperly marketed their policies provoking even more confusion and wishful thinking.

Class-action lawsuits have been filed against some life insurance companies because they sold policies as investments or pension plans, and promoted the idea that premiums would likely vanish because of anticipated investment success. That deceived those who were not life insurance alert.

There can also be needless replacement of policies. Cash value policies should never be replaced based solely on projections and illustrations of what might happen if investment returns are great or if interest rates earned by the life insurance company are high.

Life insurance is for replacement of the income of a breadwinner with dependents, or tax and estate planning, or other realistic need like collateral for a business loan or key employee insurance. It's important to be life insurance alert and buy only what is appropriate and actually needed.

It is a mistake to view life insurance as an investment and hope for great returns. Life insurance is a planning tool. Some products may generate a cash value, but that is not for investment purposes. Any cash value reduces the insurance company's margin of risk and offsets the future higher cost of premiums as the insured gets older. Such things as securities and real estate are for investment.

Think twice about this:

Amongst others, one form of life insurance to be careful about is industrial insurance or burial insurance. Does the payoff really justify the premiums? Insustrial insurance premiums tend to be high. Paying for a burial is not like replacing an income. It is a smaller one time expense. Does it really need to be insured? Anyone considering such coverage needs to examine such concerns in this life insurance alert.

Exchange life insurance alert

Should you exchange your current life insurance?

Internal Revenue Code Section 1035 provides for the exchange of an existing insurance policy for a new one with the same insured without paying tax on any profit in the original policy. It is called a "1035 Exchange."

The old insurance contract must be exchanged for the new contract without receiving any proceeds.

A tax-free exchange can be made for a life insurance policy to another life insurance policy, or a life insurance policy to an annuity. An annuity contract cannot be exchanged for a life insurance policy.

A 1035 Exchange is a form of "replacement". Not all replacements are Section 1035 Exchanges and some replacements are not tax-free.

Reasons for exchanging:

You have decided you need a different type of life insurance, e.g., you only need coverage for a certain number of years after all, and can reduce premiums by buying term, or you had term and decide you really want a permanent form of life insurance.

The new life insurance policy may be the same type but has better benefits.

The new life insurance may cost less.

The old life insurance company may no longer be as financially strong as it used to be.

Reasons against Exchanging:

Premiums on the new may be higher than the old.

A new contestability period will commence, i.e., a two-year period from the effective date of the new policy when the life insurance company issuing the new policy could refuse to pay a death claim because of a misstatement in the application.

First year marketing expenses in the new policy may deplete the cash value transferred from the old policy.

Life insurance alert charges

There may be a surrender charge to pay on the old life insurance policy. The surrender charges of the new contract may go further into the future than that of the old.

An outstanding loan against the old policy may result in being taxed.

If you need to discuss any of the issues in this life insurance alert, please contact us.

Other Considerations:

Borrowing against the old policy to pay premiums on the new is an option if there is sufficient cash value. However, it will reduce the death benefit of the old policy. It also provokes the question of why? Can the policyholder really afford both policies if borrowing is necessary? If the policyholder is overextended, the result may be the loss of both policies. That's not being life insurance alert.

¶ Nothing in this life insurance alert constitutes advice or recommendation of any nature, whether legal, tax, financial planning or otherwise. The above comments represent only the author's understanding of the subject and may be incorrect or out of date.

Life Insurance Alternatives