I recently had the opportunity to advise a couple on their term life insurance coverage and help them understand what their future would hold in terms of costs and payout. Like most people, they had forgotten that while the initial annual premium was low, at the end of each term it would increase significantly. Consequently, only 2-3% of term policies ever end up with a claim being paid because people let them go before they die, as they cannot afford to keep them. In the rare event that a term policy is kept until it expires, it will do so without cash value and there will no longer be a death benefit payable when the previously insured life dies.
Term life insurance
To illustrate this cost escalation, let’s examine a Term 10 and Term 20 life insurance cost structure for a 45-year-old male, non-smoker with a $1,000,000 death benefit.
Source: Equitable Life, as of February 25, 2021
Given the jump from $89.95 per month to $746.10 per month at the ten year renewal mark on the Term 10 plan, it’s unlikely that many would choose to keep the policy going after the renewal. Similarly, in the case of the Term 20 plan, where the insured has a level premium for twenty years, they would also be unlikely to keep the policy past the renewal. In the event that either the Term 10 or Term 20 plans were kept until the insured reached age 85, both policies would expire without a cash value and without ever having to pay a death benefit.
These term policies are purposefully designed to provide the opportunity to purchase large amounts of coverage for a limited period of time and for very little premium, to provide protection “if” the life insured dies. For example, a couple with young children and a mortgage would be well advised to carry enough life insurance to cancel that mortgage and provide ongoing lifestyle support for the surviving spouse. A rule of thumb to help determine adequate life insurance is ten to fifteen times income plus debt, less liquid assets. For most young families, this is a big number and is often a million or more. The need for this coverage is temporary because the mortgage will eventually be paid off, the children will become self-supporting and the couple will grow their asset base. For most couples, permanent insurance for this need would be cost prohibitive.
Permanent life insurance
Some life insurance needs last much longer than the limited timeframe covered by term insurance. In such cases, permanent life insurance would be more beneficial. This type of insurance is paid upon the death of the insured, and typically applies to estate planning. It could include:
- Estate equalization – used to offset estate imbalances that occur when the family business is to be passed onto one sibling who has an interest in it, leaving others otherwise disinherited.
- Estate maximization – used to magnify the estate beyond what traditional investments might provide.
- Estate liquidity – used to pay estate costs and to prepay the anticipated taxes due in the estate. For instance, on death, a RRIF account is brought into income and capital assets are deemed sold, resulting in a capital gain. Instead of the estate paying $1 for every $1 of tax owed in the estate, permanent life insurance allows for the same tax bill to be paid with pennies on the dollar.
The benefits of conversion
The good news is that most term insurance policies are convertible to permanent policies. This is a contractual option that is permitted without subjecting the life insured to new underwriting. The policy may be totally or partially converted, with the remaining term coverage either kept or dropped.
The permanent policy that results from the conversion may or may not have cash value depending on the choice made. Cash value policies require a larger premium commitment, but provide huge value. They may provide opportunities to stop paying premium for a period of time or perhaps even indefinitely.
For some policies, the cash value may eventually exceed the deposits made to the policy. This means that if surrendered, the policy owner may receive a complete refund of premium plus the possibility of some growth. The cash value grows tax-exempt, and may be used at a future date to supplement retirement cash needs. If not accessed prior to death, many policies with cash value may result in a growing death benefit. So, as with cars, cheapest is not always best!
There are many options when converting your term insurance policy. As an example, the following charts show a partial conversion of the above $1,000,000 term policy for a 45-year-old male, non-smoker to either a Whole Life or a level cost, minimum funded, Universal Life policy, both with an initial death benefit of $250,000 and premiums payable for life.
Source: Equitable Life, as of February 25, 2021
Clearly, the larger deposit into the Whole Life policy creates enhanced values compared to the Universal Life option, but each solution will appeal to different circumstances.
Everyone’s situation is unique, so the options shown here may or may not be right for you. When deciding which type of insurance policy is best for you and your loved ones, always review your needs with a qualified professional who can help you truly understand what your financial future will hold. At CWB Wealth Management, our experts provide integrated wealth solutions for our private wealth clients. Please fill out the form below if you would like one of our team members to reach out to you.
*Based on current dividend scale and assume cost of insurance and premiums paid for life with dividends being used to purchase paid up additions.
**Based on level cost of insurance, minimum funding with 0% rate of return.
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