Life Insurance Q&A - w/ FAQ Section
- Life Insurance (Term, Universal, Whole)
- Living Benefits (Critical Illness, Disability Insurance)
- Buy/Sell Agreement Funding (Business Related)
- Tax & Estate Planning (In terms of life insurance)
Frequently Asked Questions
UPDATED on November 29, 2010:
First, I would like to thank everyone for asking really good questions, presenting their scenarios and contributing to the discussion in general. I noticed that there are a lot of common questions that people have. In addition, I found out that some of the users are a bit misinformed about insurance products.
I decided to create a FAQ section in the first post to allow people to find info more easily. I will update the questions as new questions and issues come along.
1. How do I choose the right policy?
To choose an appropriate type of insurance, it is recommended to determine the need it will address. Temporary needs include outstanding mortgage, loans, education funds, etc. On the other hand, Permanent needs may include burial costs, estate taxation, charity donations, etc. The amount of the insurance policy is determined based on the personal circumstances and purpose of the policy.
2. What is Universal and Whole Life Policy?
In this type of policy you have two separate components, Insurance and Investment. Universal Life is flexible, because it gives you the option to pay just for Insurance component. If you chose to pay additional premiums, you will be funding the Investment side of the policy. This coverage will last until age 100 at which point the death benefit is paid out tax-free. You also get a guarantee that your premiums will never increase. Remember that there is a maximum amount of how much you can put towards investment side. If you go over that max, your policy loses tax-exempt status.
In this policy, there is a Cash Surrender Value (CSV) and Insurance components, which are combined. There is one premium that cannot be changed. There are two types of whole life: Participating – your policy pays-out dividends. Non-Participating – just provides lifetime coverage, or if you lapse the policy you get the value CSV.
CSV is funded by the portion of your premium leftover after you paid for cost of pure insurance.
If you are looking just for lifetime insurance coverage, Universal Life is a better option, because it is cheaper than Whole Life. If you are looking for both insurance and investment sides, Universal Life gives you flexibility in terms of premiums, compared to Whole Life. In other words, Universal Life allows you to control the investment portion of you policy, while Participating Whole Life does not.
3. ”Buy term and invest the rest” Strategy
Several users mentioned this strategy during this discussion. This strategy consists of continuously buying a term insurance and investing the rest of money that one would’ve paid for a Whole Life Policy. It is often ignored that while permanent life insurance typically costs more than term life insurance initially, it often has a level premium for your lifetime.
When you buy term life insurance and invest the premium difference in non-registered investments, it’s possible to build greater short-term investment values while living, compared to permanent life insurance. However, in the long-run the “buy term and invest the difference” concept is likely to be outperformed by a permanent life insurance policy.
Added on September 10,2010:
When you using this strategy, you are continuously buying Term insurance at the expiry. Most of the term products are renewable, which means that you renew it at the expiry (regardless of your health condition). Premiums will be based on the age at the renewal. This means that cost of the coverage will be increasing as you get older, which means spending quite a bit.
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Added on September 20,2010:
An illustration comparing Whole Life Par to "Buy term, invest the rest" strategy. Follow the link for illustration.
Added on October 17,2010:
Justification of Whole Par dividend scale is here. Important post to review, as it is important point in the scenario.
4. Tax status of Insurance Policies
Death benefit is paid-out tax free. Insurance policies also have ability to be creditor proof and bypass probate. To prevent creditors claiming from claiming your assets upon death, you need to name a beneficiary who is an individual (opposed to an organization). Withdrawals from the investment side of the insurance policy will trigger tax consequences, but there are strategies to minimize the taxation.
Added on November 29,2010:
5. Critical Illness (CI) Coverage
This coverage provides a tax-free lump-sum benefit for an insured diagnosed with a specific illness. Basic conditions include Heart Attack, Life-Threatening Cancer and Stroke. There is an option to add 21 other conditions. Some background info on CI. This product was developed by doctors, because more people are surviving illnesses considered to be fatal in the past. The proceeds of this policy could be used to pay for medical treatment not covered by OHIP. Also, these proceeds could be used to seek medical attention in US.
Critical Illness has a unique feature: Return of Premium. This option allows you refund all the premiums paid into the policy after certain period of time. Another good feature is Graded Premium. This benefit allows you to get a lower premium at the beginning. The premium increases every five years and you have an option to lock-in the rates anytime during that time. In order to take advantage of this benefit, it is recommended to lock-in the rates within first five years (this aspect may vary between individuals).
By starting this coverage early, you are locking-in the rates for the rest of the life and getting a lower premium. And with return of premium option, you can always get your premiums back.
More to follow ...