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New parents: Understand whole life insurance before buying

With the overwhelming responsibility of becoming a new parent, it’s understandable that many overlook the necessity to review their family’s financial situation, particularly as it pertains to life insurance. Your new addition to the family creates an overwhelming need to take a closer look at how life insurance can provide much needed financial security to your new family member. The tips below will provide you with a basic understanding of Whole Life insurance to assist you with shopping for, and purchasing a plan.


Do

Do understand the differences between whole life and universal life

The Differences

Whole Life
· More expensive due to high cash accumulation in the policy.
· Has a level premium that doesn’t change.
· Guaranteed lifetime protection.

Universal Life
· Less expensive due to modest cash accumulation in the policy.
· Has a flexible premium which you can pay more or less than scheduled.
· Depending on the type of Universal Life plan, coverage is not guaranteed and may lapse.

The Similarities

- Lifetime protection
- Cash Accumulation
- Loan availability

Do make some portion of your life insurance for lifetime protection

The number one goal in acquiring life insurance as a new parent is to ensure that at least your income is protected during your critical earning years while raising a family. This is more often achieved by purchasing term life insurance that provides temporary protection and is the least costly type of life insurance. However, many families and couples enjoy the security of having lifetime protection. This allows you to someday leave your spouse with a cash benefit to pay off any lingering debt or supplement their retirement; it can even help with costs associated with old age, such as for long-term care costs. Many want some permanent lifetime protection to leave a legacy for their grandchildren creating an education fund for their children’s children.

Oftentimes the above is achieved by purchasing a blend of life insurance policies. For example, if you decided your life insurance needs during your earning years was to have $1M of coverage, you could purchase $250K in permanent coverage so you can have some lifetime protection while purchasing the remaining $750K in 20 or 30 year Term insurance. This allows you the best of both worlds, providing coverage for your family during your primary income earning years, and leaving a small life insurance legacy to your family someday, hopefully far in the future.

Do consider coverage on both parents

If money is tight and coverage can only be afforded on one parent, then it’s obvious that the primary wage earner needs to have adequate income protection. However, one should never overlook the importance of having life insurance coverage on the secondary wage earner and even a stay-at-home parent. A stay-at-home spouse has been valued at over $100,000 per year. Those contributions that would be lost to the home may need to be replaced by hiring day care and housekeeping, as well as many other services.

Do understand guaranteed and non-guaranteed policy values

Guaranteed and Non-Guaranteed policy values are features of life insurance policies that determine how your policy will generate cash value. Life insurance plans that have these features are Traditional Whole Life, as well as Universal Life policies and their variants. (Term insurance is not included as it does not generate any cash value.)

Guaranteed cash value of a life insurance policy represents the amount of cash projected to be available in your policy assuming guaranteed mortality costs, guaranteed interest rates and guaranteed expense factors. Essentially what a guaranteed policy cash value is showing you is how your life insurance policy will perform in the worst case scenario (more people are dying than expected; interest rates are low and expenses to run the company is high).

Non-Guaranteed cash value of a life insurance policy represents the amount of cash projected to be available in your policy assuming current mortality (people are living longer), current interest rates (usually higher than guaranteed) and current expenses to run the insurance company (usually lower than guaranteed). Basically, what non-guaranteed projected policy values are showing you is how the policy can perform based on better than guaranteed assumptions of interest rates, mortality, and expenses.

Do know your dividend options

Life insurance dividends are paid to policy owners of mutual insurance companies. These are called participating policies, meaning policyholders participate in the companies’ better than expected investment returns, mortality charges, and expense factors. Rather than directly crediting you policy cash values with improved results, they offer you different choices as to how you may want to use your dividends. Those are as follows:

- You can use them to purchase paid up additions to your base policy. Paid up additions are fully paid for portions of life insurance. These paid up additions add to your overall death benefit, will never require an additional premium payment and add to your policy’s cash value. These additions also continue to earn dividend payments.

- You can use dividends to reduce the premium payments of your life insurance policy. In effect, when a dividend is declared, you can have them applied towards your premium payments, therefore, reducing the amount you need to pay. Over time this can reduce the cost of your out-of-pocket cost of insurance premiums.

- You can have them paid to you in cash. The life insurance company will write you a check each year for the dividends earned by your policy.


Don't

Do not buy Whole Life if your budget can only afford term insurance

If you are a new parent, it’s important to buy as much coverage as possible within your needs. For example, let’s say, based on a Survivor Needs Analysis, the calculations show you should have $1M of life insurance coverage. However, your budget is limited, and for the same dollars you can purchase $1M of 30 Years of Term Insurance or $200K of Whole Life insurance. Yes, we know that whole life builds cash value and it provides lifetime protection. However, assuming all costs are equal for each policy you should definitely get the Term coverage as it provides your family with full coverage in the event of your death.

Do not underestimate the tax benefits of whole life insurance

Cash values in your life insurance account grow tax-deferred. In addition, if you decide to surrender your policy to receive the entire policy cash value you will only pay taxes on the earned income. For example, if you paid $1,000 in policy premiums each year for 20 years and you cash the policy in and receive $30,000, you will only pay ordinary income tax on the $10,000 in earnings. An attractive option for receiving cash from your policy without paying any taxes is to borrow the cash values. This is often done as a supplemental retirement income stream, whereas you make systematic withdrawals up to your cost basis (premiums paid), and then switch to loans to withdraw profits. A knowledgeable agent can show you how to withdraw cash from a whole life contract without paying taxes.

Do not commit to more premium payments than you can afford

Life insurance is very important, however you should never purchase more than you can afford. A general rule of thumb as to how much you should be spending on life insurance is to not exceed 3% - 5% of your annual income on life insurance premiums.

Do not buy Whole Life primarily as an investment

Others may disagree, however in my opinion, Whole life insurance should not be looked at or purchased as an ‘investment vehicle’. Whole life is simply a life insurance policy with a ‘savings’ component. To say that whole life is an investment implies that there is “risk”. Investments entail risk, whereas Whole life insurance offers guarantees that investments may not offer. Some of those guarantees are steady growth of cash values and lifetime insurance protection. Someone will eventually collect on Whole Life Insurance: you if you cash in the policy, or your beneficiary when you die.

Do not overlook lapse protection features of Whole Life

One of the main concerns of life insurance policies that protect you for your ‘whole life’ is the potential for the policy to lapse. This can occur for many reasons such as withdrawal of policy cash value, lowering interest rates, policy costs, etc. Having a policy that provides ‘Guaranteed Lifetime Protection’ is a great feature. This means that your ‘whole life’ policy will remain in-force as long as you live and continue paying premiums for the life of the policy. However, although your whole life policy may guarantee lifetime protection, if you withdraw the cash values from the policy, the lifetime protection feature will be affected.


Summary
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Regardless of the type of life insurance you want to buy, the most important factor to consider is how much life insurance your family will need if the primary income earner were to die unexpectedly. Whatever figure you and your family determine is appropriate, it doesn’t matter what type of coverage you protect them with. It could be Whole Life, Universal Life, Term Life, or a blend of all three. Just make sure that you provide adequate protection for your survivors.


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Marc D. LewandowskiIndependent Life Insurance Broker

Marc D. Lewandowski has been Life & Health insurance licensed for over 10 years with experience consulting clients on product options regarding Life, Health, Disability, Long-Term Care as well as Medicare Advantage plans. Marc Lewandowski gra...

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