Brian Gruss Licensed Insurance Planner

College Funding with Permanent Life Insurance

If you own a cash value life insurance policy-universal, whole, or variable-you may be sitting on a potential gold mine for funding your children’s college education.  Why?

When you consider buying life insurance, the main reason must always be to protect your family’s lifestyle and cover their future needs.  In other words, life insurance must always be purchased because there is a need.  But there are additional features that may let you use this same life insurance for living needs, too.  Permanent life insurance-life insurance that builds cash value-can help you accomplish many goals:

·        It lets you accumulate significant cash without current taxation.[1]

·        Depending on the type of policy, you can pay additional premiums and further enhance this cash accumulation feature and the associated tax benefits.

·        There is a “borrowing” feature that lets you take out potentially large amounts of money without paying taxes.  When you pay the money back, you are repaying yourself rather than a bank.[2]

·        You may never have to pay the money you borrow back, if the policy is adequately funded.[3]

You can borrow from your life insurance policy cash value for just about any reason.  Of course, you need to pay enough in premiums to keep the life insurance policy “in force” and borrowing may mean paying more premiums to keep your policy cash value at a suggested level.  But, as long as you manage the money you borrow and keep making any necessary premium payments to the insurance company, you may be able to borrow much of the cost of your children’s college education and still keep your insurance.

Even better, if you have a sufficiently high cash value, and you keep making any necessary premium payments, you may never need to pay back the money you borrowed.  This is a fairly sophisticated approach though, so always consult with your insurance and tax advisors before you take any policy loans.

Of course, nothing is a free ride.  If you do not maintain a sufficient cash value and/or pay enough in premiums, your policy could “lapse”-it could fall apart because there is not enough cash value or cash inflow to provide the agreed upon life insurance benefit.  In this case, you might be able to reduce the policy value (face amount paid at your death) so there is enough money.  If you don’t take the right steps to keep your life insurance policy “in force”-paying premiums, paying back loans and/or maintaining enough cash value to cover the policy costs-you could lose your life insurance.  If this happens, you may have a very nasty tax problem.  Generally, if you allow an insurance policy to “lapse,” you will owe tax on any cash value above the actual amount you paid in premiums, and any unpaid loans get added to this cash value.

So, if you’re looking for additional cash to pay for that college education (or many other expenses), you may need to look no farther than your own life insurance policy.

[1] Check with your tax advisor to ensure your policy will not be subject to current taxation on cash value growth.

[2] Please check with your insurance and tax advisor to make sure your loan meets certain guidelines.  Loan interest rates may apply.

[3] Check with your insurance advisor to ensure your policy is properly structured.  If your policy lapses with an outstanding loan, loan proceeds may be subject to taxation.

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Maximizing Pension Benefits with Life Insurance Planning

Retirement signals the time for making a number of critical decisions. For individuals eligible for pension benefits, one of these decisions will involve determining the most beneficial pension option. The choices may include a lump sum benefit and some type of annuity. Two main types of annuity options available through a pension plan include a single life only annuity (which pays a benefit over the life of the retiree, but stops when the retiree dies) and a joint and survivor (J&S) annuity (which pays a benefit over the combined lives of the retiree and spouse).

The monthly benefit in a J&S annuity is less than it would be under a single life option, because the benefit potentially will be paid over two lifetimes instead of just one. For example, a retiree who would receive a monthly pension benefit of $1,700 under a single life annuity might receive $1,300 under a J&S option. Some think of a J&S annuity as a type of  “insurance,” with the “premium” for the continued benefit to the spouse being the reduction in the monthly benefit amount (in this case, $400 each month).

A retired couple may find that deciding between a single life only and a J&S annuity is difficult. If a J&S option is selected and the spouse dies before the retiree, the surviving retiree will continue to receive the reduced benefit amount, even though no benefits will ever be paid to the spouse. Conversely, when a retiree covered under a single life annuity dies, the pension stops to provide any continuing benefits to the surviving spouse.

A financial planning tool called pension maximization may provide some retirees with a way to enjoy the higher monthly benefit of the single life annuity, yet with financial protection for the spouse in the event of the retiree’s death. The basic concept of pension maximization is this: Choose the single life annuity, and use some portion of this larger monthly benefit to purchase a life insurance policy that could be used to generate income for the spouse after the retiree’s death.  If the spouse dies first, the retiree can change the beneficiary on the policy, or simply cancel the policy and pocket the money formerly used for premiums.  Furthermore, if the policy had any cash value this money could be used for another purpose.

Is pension maximization the right strategy for you? Several factors should be considered in answering this question-

• Insurability. The retiree must be able to get a life insurance policy. For those in poor health, this may not be an option.  It is critical that the retiree secure sufficient life insurance before making their pension choices.

• Financial means and discipline. The retired couple must be conscientious about making premium payments on the life insurance policy to ensure that it does not lapse. Thus, the income generated by the single life annuity (and other income sources) must be adequate to cover your living expenses, plus the cost of the life insurance premiums.

• Other income sources. What assets and investments does the retired couple have outside the pension plan? Does the spouse have a separate pension plan or retirement account?

• Pension plan COLA. Pension plans with a cost-of-living adjustment (COLA) increase the benefit amount over time for inflation. This valuable feature can make the J&S option more attractive.

• Ancillary pension benefits. Sometimes any additional benefits for a spouse-such as medical coverage-are forfeited if a single life annuity option is chosen.

The retiree considering pension maximization should consult with a qualified financial and/or tax advisor to obtain a detailed analysis that considers tax consequences and inflation. Only through such an analysis can one obtain a good picture of the “cost” of the J&S option and the amount of insurance needed to replace the survivor benefit if the single life option is chosen. That said, pension maximization offers the advantage of a higher monthly pension benefit for the lifetime of the retiree, coupled with insurance protection for the spouse. For many, it represents a smart financial planning strategy.

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How Much Life Insurance Do I Need?

How much life insurance you need depends on what you need the insurance to do.  As a general rule, the more dependents you have and the longer their dependency is expected to last, the more life insurance you need.  But even people with no dependents need some life insurance.  Let’s look at several typical situations.

People with minor children:  The younger your children are, the longer they will depend on your income. Therefore, more insurance will be needed to replace the income you would have provided, should you die while they are still young.  If both parents earn income, then both should have life insurance, with insurance amounts proportionate to the amounts they contribute to the family’s income.  If one parent stays at home with the children, there should be enough insurance to cover the cost of purchasing services, such as childcare and housekeeping, provided by this parent.  Should the family budget be insufficient to purchase policies to cover both parents, most insurance experts recommend first insuring the life of the parent who earns more.

Couples with no children or other dependents:  These individuals have no need for substantial life insurance if each could live comfortably without the other’s income.  Each should have enough life insurance to provide for burial expenses, to pay off their outstanding debts including any uninsured medical expenses, and perhaps to leave some money to charities, institutions, or valued family members and friends.  If, however, you have a spouse or domestic partner who would experience hardship without the income you provide, you may need insurance to help him or her pay the bills once you are gone.

Single People Without Dependents:  This group needs life insurance for burial expenses-which can easily reach $10,000-and for paying off their outstanding debts.  Some may want to use life insurance as well to leave contributions to favorite charities or institutions.  A young person may also want to buy life insurance so as to lock in a lower premium rate while he or she is healthy.

People who have dependents other than minor children:  Some people have parents or family members with disabilities who count on their income.  Their life insurance planning should be similar to that of parents with minor children-that is, based upon careful calculation of the amount of income their loved ones would need to continue living comfortably.

As a general guide to how much life insurance to buy, there is an old rule that suggests buying five, six, or seven times your annual salary.  But a much more reliable estimate can be made by calculating actual living expenses and the shortfall that would occur should the family no longer have your income.

Here are some of the calculations to include: What is the amount of annual income that your survivors would need to live comfortably?  This number includes mortgage or rent, insurance, real estate taxes, home repairs, improvements, furniture, appliances, and all other items bought for the home, as well as utilities and home and property maintenance.  It also includes the annual cost of food and sundries, clothing, car payments and other transportation expenses, child and other dependent care, medical care, recreation and travel, and gifts.

Once you have these annual costs calculated, subtract from that figure other sources of income that would be available in the event of your death.  For many, this includes Social Security survivor’s benefits. You can obtain an accurate estimate by contacting the Social Security Administration.  Since the actual amount would depend on your age at death, your earnings and the ages of your children, you may, instead, use the following rough estimates as a guide: $4,000 per year if you have one child under 16, or $5,000 for two or more children under 16.  Other sources of income include earnings of your spouse or other household members, pensions, investment income, etc.

Then determine the shortfall between annual expenses and income from other sources.  Ideally, the insurance benefit will generate after-tax annual investment proceeds sufficient to cover the annual income shortfall without touching the principle.  This can be determined by dividing the shortfall by 4%, 5%, or 6%, depending on how conservative you want to be.  It is reasonable to expect an annual return of 6%, but more conservative to account for inflation and interest rate risk by using one of the lower numbers.

Next, you need to determine one-time expenses that will be incurred upon your death.  These include funeral costs, any likely unpaid medical expenses, costs of estate administration and estate taxes, debts that your survivors may need to pay off at the time of your death, future education expenses for each child, and any other likely expenses, such as the cost for a surviving parent to go back to school to increase his or her earning power.  Add this amount to the amount of insurance proceeds needed that you already calculated to get an estimate of the total death benefit needed.

It’s impossible in an article of this length to go through in detail all the calculations that can be necessary to cover each individual’s situation.  The above is only a general guideline as to the type of analysis that will help most people get an accurate reading on the question of how much life insurance to buy.  Your insurance agent can help you refine this analysis to more accurately reflect your own situation.

Tags: Burial Expenses, Charities, Childcare, Couples, Dependents, Domestic Partner, Family Budget, Family Members, Group Insurance, Housekeeping, Income Insurance, Institutions, Insurance Cover, Insurance Experts, Insurance Life, Life Insurance, Medical Expenses, Outstanding Debts, Purchasing Services, Typical Situations