Life Insurance: The most misunderstood financial tool

Posted: Thursday, December 23, 2010

Life insurance is one of the most overlooked and misunderstood portions of a financial plan. Some folks swear by it. Some swear at it. Some folks get religious over it. In other words, reason goes out the window and they either bless it or curse it without examining the facts.

In our view, life insurance is simply a tool. Whether it’s good or bad depends on how it’s used in a specific situation. With that in mind, let’s go to the question of the month:

Dear Sirs: I feel like my Mom got ripped off! In 2000, my 79-year-old mother bought a $350,000 universal life insurance policy from a local representative. The premiums are very expensive—over $15,000 a year. She is a widow with an estate worth about $1.4 million. In 1998, she survived breast cancer. I recently tried to ask her why she bought that policy, but mom has Alzheimer’s. I just feel like someone may have taken advantage of her. What do you guys think?- (Name withheld by request)

Well, $15,000 a year for life insurance is expensive. However, considering your Mom’s estate is worth $1.4 million (which is about seven times the national average for net worth), a $15,000 premium, only about 1% of her net worth, sounds reasonable. If her estate is growing at all, the premiums should be covered by a small part of the estate’s growth.

In 2000, the estate tax exemption was $600,000 (meaning any net worth over that amount was taxed at a 50% rate).  If your mother were to pass during 2011, the current exemption is $1 million. Therefore, her net worth over $1 million will be taxed at 55%.  Life insurance, if it is owned by your mother's children or by a properly structured life insurance trust, can be estate tax free.  So, the $350,000 life insurance death benefit mentioned earlier would pass without tax. That makes life insurance a very powerful estate tax planning tool.

Based on just these facts, one could make a really good case for buying a life insurance policy to cover estate taxes, but your case has another interesting twist. You stated that in 2000 your Mom had recently survived breast cancer. If that’s the case, we are surprised any company insured her at all at any price.  Most companies require a five-year free of cancer wait period before insuring cancer survivors.  So, it seems like your Mom was lucky to get a policy at all.

The only caution we would offer is that almost all universal life insurance policies provide a permanent death benefit. In other words, the policy is expected to be in force even if the client dies at a very old age.  However, these death benefits and premiums may not be guaranteed.  A change in the policy’s interest rate or an increase in national morbidity and mortality death rates (which is very unlikely) could cause premiums to go up or the policy to lapse, even if the premiums are paid.

That’s why we prefer guaranteed style life insurance policies.  It is very likely that, because of your Mom’s health condition at the time, the insurance company would only issue a non-guaranteed contract. Not ideal, but certainly better than nothing. All in all, with luck regarding interest rates, this policy should serve your family well. We suggest annual reviews with a qualified insurance professional to monitor the policy's performance and to revaluate your options as time goes by.

Dan Searles and John Stohlman, owners of Medallion Financial Group, are CFP’s, financial planners and Registered Representatives offering securities and advisory services through National Planning Corporation, member NASD/SIPC, and Registered Investment Advisers. For further info, questions or comments regarding this article, Dan and John can be reached at 301-990-9704 or 1-800-878-9704 or National Planning Corporation does not endorse the opinions expressed in this column. The information here is not to be considered as financial, tax or legal advice. As with any financial, tax or legal matter, consult your qualified adviser before taking action. No investment strategy can ensure a profit or protect against a loss.

Email A Friend

Want to email a link to this article to a friend? Just enter the information below!

Your Name:
Your Email:
Friend Email:

Article Category Sign Up

If you're interested in getting more in-depth information about articles in the same categories as this article, sign up now!

Reader Feedback
No reader feedback for this article. Why not post some feedback of your own?
Reader Feedback Submission
* Required Value
Hudson Valley Parent
Powered by NeoCurve