I was reading my weekend newspapers on Sunday and came across a section of the Business Section called Smart Money. It was the typical questions and answers wire section. The person responding to the questions was Bruce Williams. And Bruce was sponsored by Newspaper Enterprise Association.
In this question G.M. of New York City stated he was buying term life insurance and wanted to know which term to buy 20 or 30 years. G.M. went on to say he had an 11 month old baby and hopefully he will have at least 1 or 2 more children. He figured that out at age 36 he would have all of his ducks in a row by age 56, saved for his children’s college, he would have a small mortgage and sufficient retirement savings. (I thought G.M. had a great income) What G.M. didn’t say was how much life insurance he thought he needed to purchase.
Bruce answers G.M. by saying “he is in his corner about term life insurance”. Bruce suggests either to buy a 10 or 20 year term life insurance policy. Bruce does remind G.M. about the ability to convert his term policy to another life insurance policy prior to the term expiring (he never tells G.M. that not all term life insurance policies are convertible), but fails to mention that G.M. would convert to a permanent life insurance policy at rates reflective of his age. Bruce fails to mention that G.M. has a far greater chance to be become disabled than to die early. (That’s one of the problems about trying to get advice from a newspaper or magazine; you are always limited to one-liners).
After reading these 2 short paragraphs, I thought what a lack of information and recommendation Bruce Williams gave this person, if there really was a G.M. The more I reread G.M.’s letter the more I saw a need for life insurance for more than 30 years. First of all, good luck on getting your children out of the house by age 25 and being able to say you have no financial responsibility for them. As far as saving for retirement, if you aren’t committing about 20% of your income towards your retirement you will fall short. And who lives in their first house forever?
The proper way to go about purchasing life insurance is first based on doing a complete financial needs analysis, then looking at what financial resources you have to commit to a life insurance program. Your personal life insurance program should include the ability for you to be insured for all of your life, simply because you can’t predict what financial responsibilities you will have in the future and when those responsibilities will cease.
Sitting down with a financial professional, like a Certified Financial Planner, can help you design a life insurance program that in most cases will show you options you haven’t considered or haven’t read about. Whether it is a blended life insurance policy or a program of both term and permanent life insurance, you need options before you get at the end of a 30 year term life insurance policy. Simply put, if you wait to convert at the end of the 30 year policy term, you will pay rates when you are 31 years older and you may not have good options for the conversion policy you are offered. Not all term life insurance companies have competitive life insurance policies you can convert too.
Just like with anything else in life; you get what you pay for and there is no free lunch when it comes to purchasing life insurance.
Monday, November 23, 2009
Thursday, November 19, 2009
The latest "great investment idea"
I was reading an article on Small and Mid Cap Mutual Funds that included S&P research. The article talked about the success of the mutual funds and included this paragraph:
S&P’s Investment Policy Committee recommends keeping 6% of portfolio holdings in mid-cap stocks, and 4% in small-cap stocks. The committee recommends a blended position, but for those hoping to pick up some additional yield, there are some signs that point to better performance from the value side of the small- and mid-cap universe compared with the growth side. S&P Equity Research estimates that earnings per share for S&P/Citigroup Mid-Cap Total Return Value index members will rise by 20% in 2009 compared with a 27% decline for its sister Growth index. Earnings for S&P/CitiGroup Small-Cap Total Return Value index members are seen rising 13%, compared with a 21% decline for the Small-Cap Growth index.
And the recommended mutual funds are:
So when you start to focus on 3 year returns, remember you are suppose to buy mutual funds for the long run or buy and hold, why would you not purchase a fixed annuity with a multi year rate guarantee? Say; 4% to 5%.
My point is; do you want to plan your retirement or college fund around maybe or could - or do you want to do planning with what will happen? Retirement Income Modeling can only support one or two variables. Not knowing how much your acount will be worth in the future is toughest variable to plan with.
It is your life.
S&P’s Investment Policy Committee recommends keeping 6% of portfolio holdings in mid-cap stocks, and 4% in small-cap stocks. The committee recommends a blended position, but for those hoping to pick up some additional yield, there are some signs that point to better performance from the value side of the small- and mid-cap universe compared with the growth side. S&P Equity Research estimates that earnings per share for S&P/Citigroup Mid-Cap Total Return Value index members will rise by 20% in 2009 compared with a 27% decline for its sister Growth index. Earnings for S&P/CitiGroup Small-Cap Total Return Value index members are seen rising 13%, compared with a 21% decline for the Small-Cap Growth index.
And the recommended mutual funds are:
My point is; do you want to plan your retirement or college fund around maybe or could - or do you want to do planning with what will happen? Retirement Income Modeling can only support one or two variables. Not knowing how much your acount will be worth in the future is toughest variable to plan with.
It is your life.
Wednesday, November 18, 2009
Have you considered your retirement income model?
Many retirement planners abide by what they call the "4% rule," which holds that if a retiree invests in a moderately risky portfolio of 60% stocks and 40% bonds, s/he can initially withdraw 4% of the assets to provide income, increase that amount in subsequent years to keep pace with inflation, and still have what is claimed to be a 90% probability of not running out of money over a 30-year retirement. Even though its proponents assert that this approach is a conservative one, it has three major flaws.
1. Losses in the early years tacked on to the regular withdrawals raise the chances of failure dramatically. T. Rowe Price has done some good research in this area, based upon a 55% stocks/45% bonds portfolio and 4% annual withdrawals, rising with inflation. The study concludes that with negative annualized returns for the first five years of retirement, there is a whopping 57% chance of running out of money within 30 years. Moreover, such significant losses are not as aberrational as some might think:
"Even in large portfolios, high standard-deviation events tend to occur far more often than a normal distribution suggests. This seems especially true on the downside, which will call this variable excess risk 'iceberg risk,' because it is mostly hidden from view but threatens major damage. It might also be called 'Noah risk,' after the proverbial flood that drowned the world.... Also, in the Biblical story, the world was amply warned about the flood but refused to listen. In contrast, icebergs reflect a type of risk that people look for but may not see."
Kent Osband, Iceberg Risk: An Adventure in Portfolio Theory (2002).
When these "black swan" events happen early-on during retirement in an individual retiree's portfolio which is also providing income, the personal costs are often catastrophic. The crucial risk to investing in stocks isn't the chance that a retiree's rate of return might vary from historical averages; it is the possibility that stocks might wipe him or her out. That risk never goes away, no matter how long the investor stays in the market. A longer horizon provides more opportunities to recover from "extreme market conditions," but it also provides more opportunities to experience them.
2. With people continuing to live longer and longer, the assumption of a 30-year retirement is a dangerous one. Today there is a 23% chance that at least one member of a 65-year-old couple will live to age 95. And with improving health care, even more people will live to 95 and beyond in the future, according to the Society of Actuaries. Indeed, a recent analysis of data from more than 30 developed countries reveals that death rates among people older than 80 are still falling. In 1950, the likelihood of survival from age 80-90 was 15-16% for women and 12% for men, compared with 37% and 25%, respectively, in 2002, and there's no sign of this longevity growth slowing down.
3. As has been reported by The Wall Street Journal, among others, the Monte Carlo simulations upon which the 90% success rate is claimed tend to underweight the risk of failure, often dramatically. "I take whatever probability of failure that comes out of your Monte Carlo simulation and add 20 percentage points," noted William J. Bernstein, author of The Four Pillars of Investing.
It's when the hypothetical becomes real that the magnitude of the problem becomes especially clear. Working with portfolio probabilities is fine — until the negative and failure statistics have names and faces.
A recent article from Kiplinger's looks at these issues from an interesting perspective. Although not typically a friend to annuities, Kiplinger's offers a twist on the traditional risk pyramid (see above). With a traditional risk-pyramid model, the safest investments — such as annuities and bank deposits — are used to build the foundation of the portfolio, with riskier investments layered on top, adding (in order) bonds and various types of stock funds until the riskiest assets (alternative investments) are placed on top. Significantly, this diversification spreads the risk, but it doesn't guarantee that the portfolio won't lose money.
The article describes the twist as follows. "By flipping the risk pyramid on its side, you can align your retirement timeline with your investment strategy. Fund your immediate income needs with risk-free investments, such as...an immediate annuity, and gradually increase the risk (and potential return) of other investments."
It's significant that even Kiplinger's recognizes the need to structure retirement planning with an annuity foundation. Income annuities (whether an immediate annuity or the annuitization of a deferred annuity) are an incredibly powerful tool for managing income needs and are almost surely the most underutilized asset in the financial world today. As reported by The Wall Street Journal, "income annuities can assure retirees of an income stream for life at a cost as much as 40% less than a traditional stock, bond and cash mix." What that efficiency means is that retirees who need a nest egg of, say, $1 million, can live the same lifestyle with as little as $600,000 in an income annuity.
As stated by Prof. David Babbel of Wharton:
"I have reviewed over 70 academic studies that have appeared since 1999, analyzing lifetime income annuities vs. other alternatives, and coauthored another major study. (Most of these are included in the reference section to this paper, as well as a handful of earlier academic studies, each marked with an asterisk.) The consensus of the literature from professional economists is that lifetime income annuities should definitely play a substantial role in the retirement arrangements of most people. How great a role depends on a number of factors, but it is fair to say that for most people, lifetime income annuities should comprise from 40% to 80% of their retirement assets under current pricing. Generally speaking, if a person has no bequest motive, or is averse to high risk, the portion of wealth allocated to annuities should be at the higher end of this range.
"Lifetime income annuities may not be the perfect financial instrument for retirement, but when compared under the rigorous analytical apparatus of economic science to other available choices for retirement income, where risks and returns are carefully balanced, they dominate anything else for most situations. When supplemented with fixed income investments and equities, it is the best way we have now to provide for retirement. There is no other way to do this without spending much more money, or incurring a whole lot more risk coupled with some very good luck."
Annuities provide a powerful foundation for any portfolio and are crucial for providing guaranteed retirement income in an efficient manner. Good financial planning demands that we use them routinely.
1. Losses in the early years tacked on to the regular withdrawals raise the chances of failure dramatically. T. Rowe Price has done some good research in this area, based upon a 55% stocks/45% bonds portfolio and 4% annual withdrawals, rising with inflation. The study concludes that with negative annualized returns for the first five years of retirement, there is a whopping 57% chance of running out of money within 30 years. Moreover, such significant losses are not as aberrational as some might think:
"Even in large portfolios, high standard-deviation events tend to occur far more often than a normal distribution suggests. This seems especially true on the downside, which will call this variable excess risk 'iceberg risk,' because it is mostly hidden from view but threatens major damage. It might also be called 'Noah risk,' after the proverbial flood that drowned the world.... Also, in the Biblical story, the world was amply warned about the flood but refused to listen. In contrast, icebergs reflect a type of risk that people look for but may not see."
Kent Osband, Iceberg Risk: An Adventure in Portfolio Theory (2002).
When these "black swan" events happen early-on during retirement in an individual retiree's portfolio which is also providing income, the personal costs are often catastrophic. The crucial risk to investing in stocks isn't the chance that a retiree's rate of return might vary from historical averages; it is the possibility that stocks might wipe him or her out. That risk never goes away, no matter how long the investor stays in the market. A longer horizon provides more opportunities to recover from "extreme market conditions," but it also provides more opportunities to experience them.
2. With people continuing to live longer and longer, the assumption of a 30-year retirement is a dangerous one. Today there is a 23% chance that at least one member of a 65-year-old couple will live to age 95. And with improving health care, even more people will live to 95 and beyond in the future, according to the Society of Actuaries. Indeed, a recent analysis of data from more than 30 developed countries reveals that death rates among people older than 80 are still falling. In 1950, the likelihood of survival from age 80-90 was 15-16% for women and 12% for men, compared with 37% and 25%, respectively, in 2002, and there's no sign of this longevity growth slowing down.
3. As has been reported by The Wall Street Journal, among others, the Monte Carlo simulations upon which the 90% success rate is claimed tend to underweight the risk of failure, often dramatically. "I take whatever probability of failure that comes out of your Monte Carlo simulation and add 20 percentage points," noted William J. Bernstein, author of The Four Pillars of Investing.
It's when the hypothetical becomes real that the magnitude of the problem becomes especially clear. Working with portfolio probabilities is fine — until the negative and failure statistics have names and faces.
A recent article from Kiplinger's looks at these issues from an interesting perspective. Although not typically a friend to annuities, Kiplinger's offers a twist on the traditional risk pyramid (see above). With a traditional risk-pyramid model, the safest investments — such as annuities and bank deposits — are used to build the foundation of the portfolio, with riskier investments layered on top, adding (in order) bonds and various types of stock funds until the riskiest assets (alternative investments) are placed on top. Significantly, this diversification spreads the risk, but it doesn't guarantee that the portfolio won't lose money.
The article describes the twist as follows. "By flipping the risk pyramid on its side, you can align your retirement timeline with your investment strategy. Fund your immediate income needs with risk-free investments, such as...an immediate annuity, and gradually increase the risk (and potential return) of other investments."
It's significant that even Kiplinger's recognizes the need to structure retirement planning with an annuity foundation. Income annuities (whether an immediate annuity or the annuitization of a deferred annuity) are an incredibly powerful tool for managing income needs and are almost surely the most underutilized asset in the financial world today. As reported by The Wall Street Journal, "income annuities can assure retirees of an income stream for life at a cost as much as 40% less than a traditional stock, bond and cash mix." What that efficiency means is that retirees who need a nest egg of, say, $1 million, can live the same lifestyle with as little as $600,000 in an income annuity.
As stated by Prof. David Babbel of Wharton:
"I have reviewed over 70 academic studies that have appeared since 1999, analyzing lifetime income annuities vs. other alternatives, and coauthored another major study. (Most of these are included in the reference section to this paper, as well as a handful of earlier academic studies, each marked with an asterisk.) The consensus of the literature from professional economists is that lifetime income annuities should definitely play a substantial role in the retirement arrangements of most people. How great a role depends on a number of factors, but it is fair to say that for most people, lifetime income annuities should comprise from 40% to 80% of their retirement assets under current pricing. Generally speaking, if a person has no bequest motive, or is averse to high risk, the portion of wealth allocated to annuities should be at the higher end of this range.
"Lifetime income annuities may not be the perfect financial instrument for retirement, but when compared under the rigorous analytical apparatus of economic science to other available choices for retirement income, where risks and returns are carefully balanced, they dominate anything else for most situations. When supplemented with fixed income investments and equities, it is the best way we have now to provide for retirement. There is no other way to do this without spending much more money, or incurring a whole lot more risk coupled with some very good luck."
Annuities provide a powerful foundation for any portfolio and are crucial for providing guaranteed retirement income in an efficient manner. Good financial planning demands that we use them routinely.
Tuesday, November 17, 2009
Term Life Insurance; right?
Is Term Life Insurance with a Return of Premium Rider really the way to go for insuring your family’s future?
We all know that Term Life Insurance is cheap. In fact the reason it is cheap is a very small percentage of death benefit claims are paid from Term Life Insurance Policies. Reason is Term Life Insurance Policies aren't kept that long or the term is up. Adding the ROP Rider can add as much as 40% to the premium. And at the end of the term of the policy you get back all the premiums you paid for the period you are insured. Great, right?
Well, what happens next? Based on the way we as consumers live, we seem to never get of debt; we want to insure our children and grand children’s future, leave money to a worthwhile cause and always maintain our standard of living. How many people do you know who are age 65 or older and have a mortgage or take care of a grandchild?
So when your term is up, what do you do – well statically people buy another Term Life Insurance Policy when the term of their Term Life Insurance Policy is over. At that time a person may or may qualify for a new life insurance policy due to health or medical reasons. And at what price?
Do yourself a favor. Before you buy that Term Life Insurance Policy with that Return of Premium Rider, ask for a permanent Life Insurance quote and compare. Compare today’s costs with tomorrow costs. Chances are it is less than the price of a cup of coffee per day. A Permanent Life Insurance Policy will at least give you something a Term Life Insurance can't– OPTIONS.
And if you haven’t figured it out, you never out grow the need for Life Insurance.
We all know that Term Life Insurance is cheap. In fact the reason it is cheap is a very small percentage of death benefit claims are paid from Term Life Insurance Policies. Reason is Term Life Insurance Policies aren't kept that long or the term is up. Adding the ROP Rider can add as much as 40% to the premium. And at the end of the term of the policy you get back all the premiums you paid for the period you are insured. Great, right?
Well, what happens next? Based on the way we as consumers live, we seem to never get of debt; we want to insure our children and grand children’s future, leave money to a worthwhile cause and always maintain our standard of living. How many people do you know who are age 65 or older and have a mortgage or take care of a grandchild?
So when your term is up, what do you do – well statically people buy another Term Life Insurance Policy when the term of their Term Life Insurance Policy is over. At that time a person may or may qualify for a new life insurance policy due to health or medical reasons. And at what price?
Do yourself a favor. Before you buy that Term Life Insurance Policy with that Return of Premium Rider, ask for a permanent Life Insurance quote and compare. Compare today’s costs with tomorrow costs. Chances are it is less than the price of a cup of coffee per day. A Permanent Life Insurance Policy will at least give you something a Term Life Insurance can't– OPTIONS.
And if you haven’t figured it out, you never out grow the need for Life Insurance.
Monday, November 16, 2009
Other Investment Alternatives
The other day I was talking with a mutual fund manager representative about their mutual fund they were promoting. I asked what direction they were going to insure they would be able to achieve their mutual fund investment objective. After a few minutes of asking me what I was referring to, I just asked “is there any chance you could project a positive gain over the next few years”, his response was “we are going to try”.
As I thought about his answer, I wondered if my clients would be satisfied with that same answer; I will try.
I was reading an article about mutual fund managers last week and the article pointed out how little mutual fund managers had of their own money invested in the mutual fund they managed. As I read on, of the mutual fund managers surveyed the average of the money that managers had in their funds was about 1%. I thought that number was very low.
I did some calculations on my computer and found that some of the same financial instruments we used 20 to 30 years ago seemed to make sense more and more especially in the lost decade.
So I looked at John Doe age 25 investing $2029 per year in an investment. Why $2029? Just stay with me. Investing that amount over the next 40 years in a paid up dividend whole life insurance policy would produce, under the current dividend scale, $245,906 of cash or a return of 5.01%. A number that far exceeds the return of the S%P 500 for the 3, 5, 7 and 10 year averages. As well as outperforming the lost decade of the 2000’s. That annual premium would produce a $100,000 death benefit in year one. And a death benefit of:
10 year - $152,069
20 year - $228,502
30 year - $326,953
40 year - $456,955
And at age 66, the policy would produce an income of $18,000 per year for the next 15 years while maintaining a death benefit at 3 times the original death benefit. While not a lot of income, John didn’t invest a lot of his money.
What a great leverage vehicle with guarantees and certainty.
How much of a guarantee or certainty do you have with your future or personal financial planning?
As I thought about his answer, I wondered if my clients would be satisfied with that same answer; I will try.
I was reading an article about mutual fund managers last week and the article pointed out how little mutual fund managers had of their own money invested in the mutual fund they managed. As I read on, of the mutual fund managers surveyed the average of the money that managers had in their funds was about 1%. I thought that number was very low.
I did some calculations on my computer and found that some of the same financial instruments we used 20 to 30 years ago seemed to make sense more and more especially in the lost decade.
So I looked at John Doe age 25 investing $2029 per year in an investment. Why $2029? Just stay with me. Investing that amount over the next 40 years in a paid up dividend whole life insurance policy would produce, under the current dividend scale, $245,906 of cash or a return of 5.01%. A number that far exceeds the return of the S%P 500 for the 3, 5, 7 and 10 year averages. As well as outperforming the lost decade of the 2000’s. That annual premium would produce a $100,000 death benefit in year one. And a death benefit of:
10 year - $152,069
20 year - $228,502
30 year - $326,953
40 year - $456,955
And at age 66, the policy would produce an income of $18,000 per year for the next 15 years while maintaining a death benefit at 3 times the original death benefit. While not a lot of income, John didn’t invest a lot of his money.
What a great leverage vehicle with guarantees and certainty.
How much of a guarantee or certainty do you have with your future or personal financial planning?
Wednesday, November 11, 2009
Why Permanent Life Insurance
Permanent life insurance provides lifelong protection, and the ability to accumulate cash value on a tax-deferred basis. Unlike term insurance, a permanent life insurance policy will remain in force for as long as you continue to pay your premiums.
Why would someone need coverage for an extended period of time? Because contrary to what a lot of people think, the need for life insurance often persists long after the kids have graduated college or the mortgage has been paid off. If you died the day after your youngest child graduated from college, your spouse would still be faced with daily living expenses. And what if your spouse outlives you by 10, 20 or even 30 years, which is certainly possible today. Would your financial plan, without life insurance, enable your spouse to maintain the lifestyle you worked so hard to achieve? And would you be able to pass on something to your children or grandchildren?
Cash Value – A Key Feature
Another key characteristic of permanent life insurance is a feature known as cash value or cash-surrender value. In fact, permanent life insurance is often referred to as cash-value insurance because these types of policies can build cash value over time, as well as provide a death benefit to your beneficiaries.
Cash values, which accumulate on a tax-deferred basis just like assets in most retirement and tuition savings plans, can be used in the future for any purpose you wish. If you like, you can borrow cash value for a down payment on a home, to help pay for your children's education or to provide income for your retirement. When you borrow money from a permanent life insurance policy, you're using the policy's cash value as collateral and the borrowing rates tend to be relatively low. And unlike loans from most financial institutions, the loan is not dependent on credit checks or other restrictions. You ultimately must repay any loan with interest or your beneficiaries will receive a reduced death benefit and cash-surrender value.
If you need or want to stop paying premiums, you can use the cash value to continue your current insurance protection for a specified time or to provide a lesser amount of death benefit protection covering you for your lifetime. If you decide to stop paying premiums and surrender your policy, the guaranteed policy values are yours. Just know that if you surrender your policy in the early years, there may be little or no cash value.
Cash Value vs. Face Amount
With all types of permanent policies, the cash value of a policy is different from the policy's face amount. The face amount is the money that will be paid at death or policy maturity (most permanent policies typically "mature" around age 100). Cash value is the amount available if you surrender a policy before its maturity or your death. Moreover, the cash value may be affected by your insurance company's financial results or experience, which can be influenced by mortality rates, expenses, and investment earnings.
"Permanent insurance" is really a catchall phrase for a wide variety of life insurance products that contain the cash-value feature. Within this class of life insurance, there are a multitude of different products. Here we list the most common ones.
Whole Life or Ordinary Life
If you're the kind of person who likes predictability over time, Whole Life insurance might be right for you. It provides you with the certainty of a guaranteed amount of death benefit and a guaranteed rate of return on your cash values. And you'll have a level premium that is guaranteed to never increase for life.
Another valuable benefit of a participating Whole Life policy is the opportunity to earn dividends. While your policy's guarantees provide you with a minimum death benefit and cash value, dividends give you the opportunity to receive an enhanced death benefit and cash value growth. Dividends are a way for the company to share part of its favorable results with policyholders. When you purchase a participating policy, it is expected that you will receive dividends after the second policy year - but they are not guaranteed. Dividends, if left in the policy, can provide an offset (and more) to the eroding effects of inflation on your coverage amount.
Variable Life
Variable Life insurance is offered via a prospectus and provides death benefits and cash values that vary with the performance of a portfolio of underlying investment options. You can allocate your premiums among a variety of investment options offering different degrees of risk and reward: stocks, bonds, combinations of both, or a fixed account that guarantees interest and principal. This type of insurance is for people who are willing to assume investment risk to try to achieve greater returns. With Variable Life you're shifting much of the investment risk from the insurance company to yourself. Good investment performance would provide the potential for higher cash values and ultimate death benefits. If the specified investments perform poorly, cash values and death benefits would drop accordingly.
Universal Life
Unlike Whole Life and Variable Life where you pay fixed premiums, Universal Life offers adjustable premiums that give you the option to make higher premium payments when you have extra cash on hand or lower ones when money is tight.
Universal Life allows you, after your initial payment, to pay premiums at any time, in virtually any amount, subject to certain minimums and maximums. You also can reduce or increase the death benefit more easily than under a traditional Whole Life policy.
Most Universal Life policies will also provide a guaranteed rate of return on your cash values, with one important exception. It is possible that you will not accumulate any cash value if any, or all, of the following circumstances occur: administrative expenses increase, mortality assumptions are changed, the insurance company's investment portfolio underperforms, premium payments are insufficient.
In recent years, there’s been considerable interest in what’s commonly referred to as Universal Life with Secondary Guarantees (also known as a “No-Lapse Guarantee”). With an ordinary Universal Life product, the policy could lapse under certain circumstances (e.g., interest rates fall below projections, insurance costs or administrative expenses rise, etc). When you buy a policy with a “secondary guarantee,” you’re guaranteed that the policy won’t lapse even if the above factors come to pass.
One of the most attractive things about Universal Life policies with Secondary Guarantees is that they provide lifelong coverage at rates that can be considerably lower than other forms of permanent insurance. That’s one of the main reasons why these policies have become so popular for estate planning purposes. If you have a federal estate tax liability (in 2008, estates valued at over $2 million are taxed), your main concern is liquidity at death. When you die, you don’t want your heirs to have to hastily sell off assets in order to pay estate taxes. With a Universal Life policy with Secondary Guarantees, the death benefit is guaranteed for life and you have the flexibility of adjusting your premiums, a valuable feature since estate tax rates and exclusion amounts keep changing from year to year.
Variable Universal Life
Variable Universal Life insurance is a flexible premium, permanent life insurance policy that allows you to have premium dollars allocated to a variety of investment options, offering varying degrees of risk and reward. These policies are a good choice for people seeking maximum flexibility. Should your insurance needs change over time, Variable Universal Life usually provides the flexibility to increase or decrease your amount of coverage. You can also make a lump-sum payment to increase the policy's cash value. (The maximum lump-sum payment is subject to IRS limitations.) And, should an emergency arise and you are short on cash, you may be able to skip a scheduled payment and let the accumulated cash value cover the policy's expenses. Keep in mind that the cost of insurance and administrative expenses are still incurred. As your insurance needs change, it is quite probable so will your long-term investment goals and risk-tolerance levels. With Variable Universal Life, you have flexibility to transfer funds between the investment divisions, tax free. So, you have the freedom to make decisions based on your needs and not on the tax ramifications.
Why would someone need coverage for an extended period of time? Because contrary to what a lot of people think, the need for life insurance often persists long after the kids have graduated college or the mortgage has been paid off. If you died the day after your youngest child graduated from college, your spouse would still be faced with daily living expenses. And what if your spouse outlives you by 10, 20 or even 30 years, which is certainly possible today. Would your financial plan, without life insurance, enable your spouse to maintain the lifestyle you worked so hard to achieve? And would you be able to pass on something to your children or grandchildren?
Cash Value – A Key Feature
Another key characteristic of permanent life insurance is a feature known as cash value or cash-surrender value. In fact, permanent life insurance is often referred to as cash-value insurance because these types of policies can build cash value over time, as well as provide a death benefit to your beneficiaries.
Cash values, which accumulate on a tax-deferred basis just like assets in most retirement and tuition savings plans, can be used in the future for any purpose you wish. If you like, you can borrow cash value for a down payment on a home, to help pay for your children's education or to provide income for your retirement. When you borrow money from a permanent life insurance policy, you're using the policy's cash value as collateral and the borrowing rates tend to be relatively low. And unlike loans from most financial institutions, the loan is not dependent on credit checks or other restrictions. You ultimately must repay any loan with interest or your beneficiaries will receive a reduced death benefit and cash-surrender value.
If you need or want to stop paying premiums, you can use the cash value to continue your current insurance protection for a specified time or to provide a lesser amount of death benefit protection covering you for your lifetime. If you decide to stop paying premiums and surrender your policy, the guaranteed policy values are yours. Just know that if you surrender your policy in the early years, there may be little or no cash value.
Cash Value vs. Face Amount
With all types of permanent policies, the cash value of a policy is different from the policy's face amount. The face amount is the money that will be paid at death or policy maturity (most permanent policies typically "mature" around age 100). Cash value is the amount available if you surrender a policy before its maturity or your death. Moreover, the cash value may be affected by your insurance company's financial results or experience, which can be influenced by mortality rates, expenses, and investment earnings.
"Permanent insurance" is really a catchall phrase for a wide variety of life insurance products that contain the cash-value feature. Within this class of life insurance, there are a multitude of different products. Here we list the most common ones.
Whole Life or Ordinary Life
If you're the kind of person who likes predictability over time, Whole Life insurance might be right for you. It provides you with the certainty of a guaranteed amount of death benefit and a guaranteed rate of return on your cash values. And you'll have a level premium that is guaranteed to never increase for life.
Another valuable benefit of a participating Whole Life policy is the opportunity to earn dividends. While your policy's guarantees provide you with a minimum death benefit and cash value, dividends give you the opportunity to receive an enhanced death benefit and cash value growth. Dividends are a way for the company to share part of its favorable results with policyholders. When you purchase a participating policy, it is expected that you will receive dividends after the second policy year - but they are not guaranteed. Dividends, if left in the policy, can provide an offset (and more) to the eroding effects of inflation on your coverage amount.
Variable Life
Variable Life insurance is offered via a prospectus and provides death benefits and cash values that vary with the performance of a portfolio of underlying investment options. You can allocate your premiums among a variety of investment options offering different degrees of risk and reward: stocks, bonds, combinations of both, or a fixed account that guarantees interest and principal. This type of insurance is for people who are willing to assume investment risk to try to achieve greater returns. With Variable Life you're shifting much of the investment risk from the insurance company to yourself. Good investment performance would provide the potential for higher cash values and ultimate death benefits. If the specified investments perform poorly, cash values and death benefits would drop accordingly.
Universal Life
Unlike Whole Life and Variable Life where you pay fixed premiums, Universal Life offers adjustable premiums that give you the option to make higher premium payments when you have extra cash on hand or lower ones when money is tight.
Universal Life allows you, after your initial payment, to pay premiums at any time, in virtually any amount, subject to certain minimums and maximums. You also can reduce or increase the death benefit more easily than under a traditional Whole Life policy.
Most Universal Life policies will also provide a guaranteed rate of return on your cash values, with one important exception. It is possible that you will not accumulate any cash value if any, or all, of the following circumstances occur: administrative expenses increase, mortality assumptions are changed, the insurance company's investment portfolio underperforms, premium payments are insufficient.
In recent years, there’s been considerable interest in what’s commonly referred to as Universal Life with Secondary Guarantees (also known as a “No-Lapse Guarantee”). With an ordinary Universal Life product, the policy could lapse under certain circumstances (e.g., interest rates fall below projections, insurance costs or administrative expenses rise, etc). When you buy a policy with a “secondary guarantee,” you’re guaranteed that the policy won’t lapse even if the above factors come to pass.
One of the most attractive things about Universal Life policies with Secondary Guarantees is that they provide lifelong coverage at rates that can be considerably lower than other forms of permanent insurance. That’s one of the main reasons why these policies have become so popular for estate planning purposes. If you have a federal estate tax liability (in 2008, estates valued at over $2 million are taxed), your main concern is liquidity at death. When you die, you don’t want your heirs to have to hastily sell off assets in order to pay estate taxes. With a Universal Life policy with Secondary Guarantees, the death benefit is guaranteed for life and you have the flexibility of adjusting your premiums, a valuable feature since estate tax rates and exclusion amounts keep changing from year to year.
Variable Universal Life
Variable Universal Life insurance is a flexible premium, permanent life insurance policy that allows you to have premium dollars allocated to a variety of investment options, offering varying degrees of risk and reward. These policies are a good choice for people seeking maximum flexibility. Should your insurance needs change over time, Variable Universal Life usually provides the flexibility to increase or decrease your amount of coverage. You can also make a lump-sum payment to increase the policy's cash value. (The maximum lump-sum payment is subject to IRS limitations.) And, should an emergency arise and you are short on cash, you may be able to skip a scheduled payment and let the accumulated cash value cover the policy's expenses. Keep in mind that the cost of insurance and administrative expenses are still incurred. As your insurance needs change, it is quite probable so will your long-term investment goals and risk-tolerance levels. With Variable Universal Life, you have flexibility to transfer funds between the investment divisions, tax free. So, you have the freedom to make decisions based on your needs and not on the tax ramifications.
Tuesday, November 10, 2009
Term Insurance 101
As the name implies, term insurance provides protection for a specific period of time and generally pays a benefit only if you die during the "term." Term periods typically range from one year to 30 years, with 20 years being the most common term.
Advantages:
One of the biggest advantages of term insurance is its lower initial cost in comparison to permanent insurance. Why is it cheaper when initially purchased? Because with term insurance, you're generally just paying for the death benefit, the lump sum payment your beneficiaries will receive if you die during the term of the policy. With most permanent policies, your premiums help fund the death benefit and can accumulate cash value.
Term insurance is often a good choice for people in their family-formation years, especially if they're on a tight budget, because it allows them to buy high levels of coverage when the need for protection is often greatest. Term insurance is also a good option for covering needs that will disappear in time. For instance, if paying for college is a major financial concern but you're pretty sure that you won't need life insurance coverage after the kids graduate, then it might make sense to buy a term policy that'll get you through the college years.
When the Term Ends:
But what happens if you buy a term policy only to realize at the end of the term that you still have a need for life insurance? Well, it's sort of a good news, bad news story. The good news is that many policies will give you the option to renew your policy when you reach the end of the term. The bad news is that you'll probably face much higher costs since age is one of key factors used to determine life insurance premiums. To renew the policy, you also may have to present evidence of insurability (that's insurance jargon meaning, "take another medical exam and answer a new round of questions about your lifestyle, health status and family health history"). If you're still a fine specimen with healthy living habits, you might requalify at a reasonable rate. But if your health has deteriorated, you may find that it's too expensive to renew your policy or you may not even requalify.
So if you're considering a term policy, make sure you carefully consider how long you'll need the coverage. If you're pretty sure that your needs are temporary, then term insurance is probably the right choice for you. But if you think there's a possibility that you might need the coverage for a long time, then remember that if you want to renew your term policy after it expires or buy a new term policy at that time, your age, health status or other factors may make coverage very expensive.
To better understand term insurance, consider this analogy. When you purchase term insurance, it's sort of like renting a house. When you rent, you get the full and immediate use of the house and all that goes with it, but only for as long as you continue paying rent. As soon as your lease expires, you must leave. Even if you rented the house for 30 years, you have no "equity" or value that belongs to you.
Return-of-Premium Option:
One exception to this rule is what's called a return-of-premium term policy. With these policies, if you keep the policy in force for the entire term, say 20 years, the insurance company will refund the premium payments you made over that 20-year period. Of course, there is a price to be paid for this added benefit. The premiums for return-of-premium policies are considerably higher than premiums for standard term policies. The price difference can be 20%, 30% or more. Another factor to consider is that term insurance rates have dropped considerably over the past decade, mostly because people are living longer. If you own a standard term policy, there's really no harm done in dropping that policy in favor of a newer and cheaper term policy. But if you own a return-of-premium policy, dropping the policy before the full term has expired means that you will have paid a high price for your term insurance coverage and the premiums you paid won't be fully refunded. At best, you'll get a partial refund of the money you put into your policy to that point.
Key Policy Provisions:
When considering a term purchase, one thing to keep in mind is that not all term policies are the same. Some may include certain provisions as standard features, while others may require you to pay extra to add these features as "riders" to your policy. So if you're comparing term policies, remember that price is not the only factor to consider. Ask your agent about provisions such as:
Accelerated death benefits - allows a terminally ill person to collect a significant portion of his or her policy's death benefit while that person is still alive
Disability waiver of premium - waives premiums when a policy owner suffers a long-term disability, typically one lasting six months or longer
Accidental death benefits - doubles or triples the benefit in the case of death by accidental means
Convertibility:
Another provision that is very important is something called convertibility. Some insurance contracts only allow "conversion" in the first few years of the policy, while others allow it at any point during the term. This valuable feature allows you to convert your term policy to a permanent policy (e.g., whole life insurance) without submitting evidence of insurability. Being able to convert to a permanent policy is a great option to have in the event that circumstances in your life change such as failing health or maybe just the realization that coverage is needed for a longer period of time than you originally anticipated. That's why when purchasing a term policy, it's never a bad idea to find out what kind of permanent policies are offered by the company you are considering. Some companies may only have strong term insurance offerings, while others may have very competitive products in both categories.
Advantages:
One of the biggest advantages of term insurance is its lower initial cost in comparison to permanent insurance. Why is it cheaper when initially purchased? Because with term insurance, you're generally just paying for the death benefit, the lump sum payment your beneficiaries will receive if you die during the term of the policy. With most permanent policies, your premiums help fund the death benefit and can accumulate cash value.
Term insurance is often a good choice for people in their family-formation years, especially if they're on a tight budget, because it allows them to buy high levels of coverage when the need for protection is often greatest. Term insurance is also a good option for covering needs that will disappear in time. For instance, if paying for college is a major financial concern but you're pretty sure that you won't need life insurance coverage after the kids graduate, then it might make sense to buy a term policy that'll get you through the college years.
When the Term Ends:
But what happens if you buy a term policy only to realize at the end of the term that you still have a need for life insurance? Well, it's sort of a good news, bad news story. The good news is that many policies will give you the option to renew your policy when you reach the end of the term. The bad news is that you'll probably face much higher costs since age is one of key factors used to determine life insurance premiums. To renew the policy, you also may have to present evidence of insurability (that's insurance jargon meaning, "take another medical exam and answer a new round of questions about your lifestyle, health status and family health history"). If you're still a fine specimen with healthy living habits, you might requalify at a reasonable rate. But if your health has deteriorated, you may find that it's too expensive to renew your policy or you may not even requalify.
So if you're considering a term policy, make sure you carefully consider how long you'll need the coverage. If you're pretty sure that your needs are temporary, then term insurance is probably the right choice for you. But if you think there's a possibility that you might need the coverage for a long time, then remember that if you want to renew your term policy after it expires or buy a new term policy at that time, your age, health status or other factors may make coverage very expensive.
To better understand term insurance, consider this analogy. When you purchase term insurance, it's sort of like renting a house. When you rent, you get the full and immediate use of the house and all that goes with it, but only for as long as you continue paying rent. As soon as your lease expires, you must leave. Even if you rented the house for 30 years, you have no "equity" or value that belongs to you.
Return-of-Premium Option:
One exception to this rule is what's called a return-of-premium term policy. With these policies, if you keep the policy in force for the entire term, say 20 years, the insurance company will refund the premium payments you made over that 20-year period. Of course, there is a price to be paid for this added benefit. The premiums for return-of-premium policies are considerably higher than premiums for standard term policies. The price difference can be 20%, 30% or more. Another factor to consider is that term insurance rates have dropped considerably over the past decade, mostly because people are living longer. If you own a standard term policy, there's really no harm done in dropping that policy in favor of a newer and cheaper term policy. But if you own a return-of-premium policy, dropping the policy before the full term has expired means that you will have paid a high price for your term insurance coverage and the premiums you paid won't be fully refunded. At best, you'll get a partial refund of the money you put into your policy to that point.
Key Policy Provisions:
When considering a term purchase, one thing to keep in mind is that not all term policies are the same. Some may include certain provisions as standard features, while others may require you to pay extra to add these features as "riders" to your policy. So if you're comparing term policies, remember that price is not the only factor to consider. Ask your agent about provisions such as:
Accelerated death benefits - allows a terminally ill person to collect a significant portion of his or her policy's death benefit while that person is still alive
Disability waiver of premium - waives premiums when a policy owner suffers a long-term disability, typically one lasting six months or longer
Accidental death benefits - doubles or triples the benefit in the case of death by accidental means
Convertibility:
Another provision that is very important is something called convertibility. Some insurance contracts only allow "conversion" in the first few years of the policy, while others allow it at any point during the term. This valuable feature allows you to convert your term policy to a permanent policy (e.g., whole life insurance) without submitting evidence of insurability. Being able to convert to a permanent policy is a great option to have in the event that circumstances in your life change such as failing health or maybe just the realization that coverage is needed for a longer period of time than you originally anticipated. That's why when purchasing a term policy, it's never a bad idea to find out what kind of permanent policies are offered by the company you are considering. Some companies may only have strong term insurance offerings, while others may have very competitive products in both categories.
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