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long term life insurance

Whole vs Term Life

Life Insurance Fraud

An Investment, not

Life insurance is not an investment. It is also not about having a nest-egg or savings plan for retirement. That sort of characterization is a mistake because life insurance is not in an investment or savings account category. It is a financial product used in estate planning. It is not an investment opportunity which may yield a profit if things go the right way during your lifetime, like investing in real estate or securities. Life insurance is not an alternative to investing. It is a promise to pay upon the death of the insured.

Permanent life insurance uses a bookkeeping mechanism commonly referred to as a cash value or non-forfeiture value. It is not a savings account and even though some of the prepayment of premium is invested, that does not mean that any life insurance is an opportunity to invest. Any cash value reduces the insurance company's margin of risk and offsets the need for higher premiums as the insured gets older.

As you get older, the cost of insurance goes up, but with the increasing non-forfeiture value the net amount insured is reduced. So as the non-forfeiture value progressively approaches the promised payout (face amount), the increasing cost of insurance per $1,000 is counter-balanced by the lessening amount of net insurance coverage.

Even though the owner of the policy may be allowed to borrow according to the cash value figure, the reason for the accumulation of cash value is to enhance the financial stability of the insurance company. It is not a feature designed to be a reason to buy permanent life insurance. It may be a side benefit, but does not exist primarily for the benefit of the policy owner. The "loan" is really an advance of part of the face amount which must inevitably be paid out anyhow.

The basic idea behind life insurance is that a contract with an insurance company will pay a lump sum of money to dependents to compensate for the loss of your income, or to business partners to compensate for the loss of your expertise, should you suffer a premature death.

Life insurance contracts are for replacement of the income of a family breadwinner, or tax and estate planning, or other realistic needs like collateral for a business loan or to compensate a business for the loss of a key employee or to allow partners to buy the share of the business belonging to the deceased partner.

Reasons to Buy Permanent Insurance

In estate planning, life insurance can be used to have cash available to pay estate taxes so assets do not have to be sold to do so. Permanent insurance, such as Whole Life or Universal Life, is used for that purpose.

If qualified, an applicant who is concerned about taking financial care of beneficiaries after death can buy permanent insurance to take care of that, and then feel free to use and enjoy retirement savings without any concern about having too little left for heirs. Again, permanent insurance, not Term Life which could expire prematurely, is needed for that purpose.

There is a third reason that some people buy permanent life insurance. They want to provide an estate for beneficiaries but are reluctant to invest all or part of their capital in any way that may, in the short or long term, have any risk. They want preservation of capital as top priority for all or part of their available cash. They can choose a savings account, certificates of deposit, permanent life insurance, or other such safe haven.

Financial know-alls are not justified in condemning such a choice of permanent life insurance on the grounds that the financial result is not as good as investment results may be. Permanent life insurance purchased because of preference alone should be compared to other conservative alternatives, not securities investing.

Permanent life insurance should never be evaluated as if it is an investment. It is illegal and against insurance regulations to sell life insurance as if it is an investment. Life insurance has a financial result, but that happens when you die. Investment returns are looked for when you are alive.

So it is a mistake to compare the financial results of permanent life insurance with the results of investing as a basis for deciding whether or not to buy permanent life insurance. Permanent life insurance is purchased for specific financial planning reasons, not investment reasons (unless you are very mistaken).

whole term

Because it's a contract for the benefit of those with an insurable interest, not an investment, life insurance proceeds are not taxable when life insurance is purchased for that purpose.

'Buy Term and Invest the Difference' Misses the Mark

The mistake of categorizing permanent life insurance as an investment has a slogan. This trite slogan that has been parroted many times, i.e, "Buy term and invest the difference". This is drivel. If it is meant to imply that permanent life insurance is a bad investment, it is incorrect because permanent life insurance is not an investment at all. If the slogan is meant to imply that permanent life insurance is always a bad idea, it is incorrect because permanent life insurance is ideal for certain situations where Term Life is not suitable.

Term Life is appropriate for certain situations but not appropriate for certain other situations. Neither Term nor permanent life insurance is appropriate for every situation. The silly slogan is catchy, but not informative or helpful. Postulating it as a rigid rule for everyone to follow is preposterous.

By contrast, here are helpful statements: Need coverage for a few years? Buy term. Need coverage for a lifetime? Buy permanent. Select what you need for your personal situation. Investing? That's another subject.

The difference in premiums is not a basis for investing. What if the "difference" is needed for groceries or housing or education? What does the difference have to do with investing? Nothing. Whole Life and Universal Life insurance are NOT investments even if they do have an internal bookkeepinging mechanism often called "cash value".

The non-forfeiture value or cash value is not an investment return. It represents the current state of accumulation in a bookeeping mechanism towards finally equalling the death benefit (face amount). It cannot be withdrawn while the policy is in force because it is not a savings account. If it is borrowed against, the death benefit is reduced by the amount borrowed. If the policy is surrendered and there is a cash value, you receive the cash value less surrender charges, known as the surrender value.

That amount is not an investment return, not a withdrawal of savings, but is a refund of some of the money paid in because you have paid more than what the insurance coverage has cost so far. You had to pay more than the insurance coverage had cost so that the premium could stay level every year. Otherwise, the premium would have to have cost more each year as you got older. The older you get, the more life insurance costs. So you overpay during the first half of your expected lifespan, and you underpay during the last half, so that you can pay a level premium every year.

The Urban Myth

There is an urban myth that all or most life insurance agents/brokers (insurance producers) are dedicated to fooling people into buying inappropriate permanent life insurance because they make more commission than in a Term Life sale. Some financial journalists love to perpetuate this myth so that they can pose as protectors of the public by falsely portraying all life insurance producers as shameless tricksters.

Actually, there are the incompetent and the dishonest in every occupation, but that should not be used to smear the reputation of everyone in the business as some journalists like to do to insurance producers. People buying permanent life insurance know how its cost compares to Term Life and make a choice based upon their own personal needs and inclination. Getting quotes on both categories is so easy, it's not realistic to say that buyers don't make their own comparisons so they can choose according to personal preference and perceived financial planning need.

Improper Marketing

Sometimes a company makes the mistake of improperly marketing policies as investments or pension plans.

This is penalizeded by insurance regulators, usually with fines of varying amounts. Since life insurance is not an investment, companies and insurance producers are not allowed to present it as such.

Another marketing mistake is promoting the idea that premiums will likely vanish because of projected high investment returns by an insurance company's illustrations of expected future performance. The consequence is again sanctions and fines by regulators, not to mention class action lawsuits, especially when the unrealistic projections do not materialize.

Policy Replacement

Needless replacement of a policy is a bad mistake. Cash value policies should never be replaced based solely on projections and illustrations of what might happen in a new replacement policy. The investment returns of the insurance company may not be as great as hoped for. The interest rates earned by the life insurance company may not turn out to be as high as expected. Illustrations can be overly optimistic and should rather be viewed pessimistically.

life insurance rating

There is a replacement form which must be signed when replacing one life insurance policy with another. The form is designed to help you avoid a mistake so you need to be aware of the issues referred to in the form. It lists issues to be considered before signing off on the transaction.

Exchanging 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.

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.

Borrowing to Add More

Someone wanting to have more coverage but being a little short on money may be tempted to borrow against the cash value of an existing policy to help pay for the additional coverage.

Borrowing against the old policy to pay premiums on the new may 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 becomes overextended, the result may be the loss of both policies.

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