Term Vs Permanent: Which Life Insurance Policy Is Right For You?

By lwmdemo4,

Life insurance planning is a topic that is often very confusing for the average individual. There are various different types of insurance products available, and it is not always clear which solution is the most suitable for an individual to select. In order to make an educated decision, it is imperative to obtain at least a basic understanding of how life insurance products work and what form they are issued in. There are two basic forms of life insurance, term coverage and permanent coverage. While often times financial professionals will advocate convincingly for one or the other, neither is always correct.

Term Insurance is a type of coverage that is issued for a specific term, as the name would imply. Coverage will typically range from 10 to 30 years in duration. At the end of the policy period, the policy simply expires leaving you without any coverage and with no accumulated cash value. The premiums which are paid directly to the insurance company are substantially less than that of a similarly issued permanent insurance coverage.

Permanent Insurance itself comes in multiple forms. They are Variable, Universal and Whole Life policies. Each of these policies are designed to accumulate a cash-value component that can be viewed as an investment towards retirement, as well as a source of funds to pay for the policy premiums later in life. The policy premiums are typically significantly more than those for a term policy with an equal amount of corresponding insurance coverage.

The younger the age of the insured at issuance, the stronger the argument for term coverage will be. The principal behind this argument is that there is no need for life insurance unless you have a financial dependent. Insurance is a contract of indemnity. There is little reason to buy any life insurance if you are not married, have no children or any other dependents. However, it is imperative that a younger couple with minor children carry adequate insurance to care for their dependents. The cost of insurance has a much greater effect on their budget in their early years of accumulating wealth. In the event that they have excess cash flow above the cost of insurance premiums, the case for using life insurance as a savings mechanism is not very strong. More often than not, it will pay to redirect any additional cash flow towards increasing 401k or other employer-sponsored retirement-savings plan. If those features have been maximized, then other tax-sheltered savings options, such as an IRA or Roth IRA, should be explored. If an individual should pass away at a younger than traditional age, their dependents would inherit both the death benefit of the insurance policy as well as the the additional retirement savings.

As you get further on in years, there may be a number of circumstances when the benefit of a term-life policy is not as clear. In the case of an individual or couple who may still have dependents, a term policy may not offer a long enough coverage period. Term insurance most often does not extend past 80 years of age. In the event that a pension benefit stops with the death of a spouse, leaving the other spouse without a sufficient, permanent coverage should be considered. While ideally it would be preferable to use the extra cash flow to have money saved for such an event, this isn’t done and in many cases it is too late and the clock cannot be rewound. It is not uncommon for Americans to live into their 90’s today, what if the spouse with a pension benefit passes away at age 81, just after his term-insurance coverage expired. If the surviving spouse were to reach age 95, they would be forced to deal with a significant period of time in which they may not have a sufficient income. As you age, the amount of coverage needed to replace a pension declines as a person’s life expectancy shortens. In such a case, a permanent policy can be tailored with a decreasing death benefit as the years go by to keep policy premiums under control.

Small business planning is another area in which permanent insurance policies can be a benefit. When business partners enter into an agreement to form a partnership, it is fairly common to create what can be known as a Buy/Sell Agreement, or for multiple partners a Cross-Purchase Agreement. These are agreements in which two or more partners establish an agreement to buy out the other’s interest in the business upon death, disability or some other circumstance in which one party can no longer contribute to the business. In most cases, the surviving partners do not wish to bring their deceased partners heirs to the estate as a new partner. The insurance allows them the funding to buy out the deceased party’s interest from their beneficiaries. While term insurance can theoretically suffice for this need, in the case of an older partner who remains active, the limitation on time with a term policy can be problematic. Additionally, the economic value of the business entity may be growing, which requires additional insurance coverage over time. In order to avoid underwriting risks in future years, a universal policy can be structured with an increasing amount of insurance to compensate for this concern.

Tax benefits can often be cited as a reason to use permanent insurance. This is certainly true in the case of the minimization of estate taxes through what is known as an Irrevocable Life Insurance Trust. This is an estate-planning technique which typically requires insurance to continue in perpetuity. Considering the recent increases in the estate-tax thresholds, this technique has become much less common.

Another tax benefit is the ability to shelter money for the purpose of college planning and retain eligibility for financial aid by hiding money outside the view of FAFSA applications for federal student aid. This is not the most economical method to shelter money as insurance is much more expensive than other forms of tax shelters such as some low-expense versions of variable annuities that are issued without a sales charge by some prominent mutual-fund companies.

More recently, a number of hybrid-type life insurance products have been developed. One example is a term insurance policy that offers a convertibility feature to a permanent policy at the end of the term. This is extremely attractive to younger individuals. It permits you to buy 30 years of term coverage at only a nominally higher premium over traditional term, with the ability to convert it to permanent insurance if, for example, you should be diagnosed with a serious or terminal condition just before the end of the term. In the case of my example, such a diagnosis could make it difficult, if not impossible, to get a new policy. This convertibility allows the insured to continue the policy without evidence of insurability as a new permanent policy. The insured would be subject to the higher premiums associated with permanent insurance if they opted to convert, or they could simply let the term expire if there was no need for the additional coverage.

One of the more interesting new coverage options available for those approaching retirement is hybrid universal insurance coverage coupled with a long-term care policy. They can offer the ability to pay for a long-term care benefit, that if needed will simply be a draw against what would otherwise have been a death benefit. Most often these policies should be purchased for the LTC benefit itself, with the life insurance coverage being a secondary benefit to make sure the policy premiums are not simply wasted…which can be a concern with traditional long-term care policies. While this approach is more expensive than buying a traditional LTC policy, there is at least a guarantee of some form of a return on the insured’s money, whereas traditional LTC coverage can be very expensive that is never used and pays nothing back to the policy holder or their beneficiaries.

Ultimately, insurance planning, not unlike all forms of financial planning, is specific to the individual circumstance. There are no absolute product solutions which apply to us all. It is important to educate yourself on the topic before committing to a contract, because most insurance professionals are compensated on a commission basis. The more expensive product they sell you, the more money they will make. In some cases, the more expensive product may be necessary, but that is not always the case, and it is not the case in the majority of circumstances.

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Using Charitable Trusts For Tax And Estate Planning

By lwmdemo4,

Charitable donations are something that Americans are inclined to do more so than citizens of virtually every nation on earth. This is in part a result of the fact that the US is the wealthiest nation on earth and has the largest per capita GDP of any of the large industrialized nations of the world. Being charitably inclined can mean volunteering one’s time or their financial resources. In the case of monetary contributions, charitable donations can offer some financial planning benefits that can impact an individual’s estate and tax planning in positive ways. In order to qualify for these benefits, the contribution must be made to a registered 501(c)(3) organization, which is a qualifying status the IRS gives to non-profit organizations.

One common benefit of donating to a charity is the tax deduction that can be used against an individual’s income-tax liability. In order to take the deduction you must itemize deductions on your IRS Form 1040 rather than take the standard deduction. However, there are limits to this deduction. As a general rule, you can deduct a donation of cash up to 50% of your Adjusted Gross Income (AGI). In the case of property, the limit is typically 30% of your AGI. In the case of a donation of stock, mutual funds or property, the amount donated will be based on the fair market value of the asset at the time of the contribution.

In some cases, the main motivating driver of the charitable contribution is not necessarily the immediate reduction in income tax liability, but rather the reduction in the size of an individual’s taxable estate. This is particularly common in the case of individuals who may have no direct heirs or have an estate large enough that they have little concern for the heirs being left in good financial condition upon their passing. Estate planning to limit the exposure to estate taxes has become substantially easier in recent years for the average American when evaluating their federal estate tax liability. The Applicable Exemption amount for 2014 is $5.34 million. Because of the new rules permitting portability, that is a joint credit of more than $10 million for a couple if an IRS 706 form is filed within nine months of the deceased’s passing. However, when looking at the individual state laws, the thresholds are not always so forgiving. As an example, in New York any estate in excess of $1 million will have an estate tax levied that can range as high as 16%. Additionally, portability rules which allow you to claim a credit for your deceased spouse’s Applicable Exemption do not apply in New York. Each state has their own tax law pertaining to estates and/or an inheritance.

Those individuals who are charitably inclined and would prefer to see their assets pass on to what they may deem to be a worthy cause rather than the state or federal government should consider a number of potential estate planning strategies. Among them would be a Charitable Remainder Trust. These types of trusts are drafted in more than one form.

One such form is called a Charitable Remainder Unit Trust (CRUT). Under this type of trust, the assets that are placed into the trust will eventually go to the eligible charitable organizations upon the termination of the trust, which is commonly the death of the grantor of the assets. The trust is then required to pay back to a non-charitable beneficiary (also commonly the grantor) a fixed percentage of the trust’s assets annually until it is terminated. The termination of the trust can be triggered by the death of the grantor or be based on a specific number of years. This is a technique that permits the grantor to continue to receive income from the trust while removing the principal assets from their taxable estate to later be paid to a charity. The payments are typically required to be between 5-50% of the trust’s assets.

Another strategy is the Charitable Remainder Annuity Trust (CRAT). This trust operates in a similar manner, but rather than pay back a fixed percentage of the trust assets annually, it makes a fixed-annuity payment of a specific dollar amount each year.

Yet another option is what is called a Net Income with Makeup Charitable Remainder Unit Trust (NIM-CRUT). In the case of the NIM-CRUT, the trust also pays a fixed percentage of the trust assets not to be less than 5% back to the stated income beneficiary. In the event that the trust assets generate less income in a given year than the stated minimum percentage of the trust payement, then the payment is made in the amount of the trust’s income. The reason for this is that a NIM-CRUT does not permit the trust to invade the principal value of the investments for the purpose paying the non-charitable beneficiary the annual income payments.

Another option available is a Charitable Pooled Income Fund. In the case of this type of charitable contribution, the grantor pools his or her donation with that of other investors. These types of funds are commonly created by large financial institutions who manage the assets for you, or directly by a charity themselves. The disadvantages are that the investment options are limited to those available in the fund and high minimum investments may be required. Additionally, while you may be saving on the expense of having to obtain an attorney to draft a trust for you, you will incur the annual expense of the financial institution managing the pooled income fund on your behalf with very limited investment options.

Another benefit associated with each of these strategies is that assets donated to any of these forms of charitable trusts will eliminate capital gains assessed on appreciated assets. Unlike a gift to a relative, friend or some other non-charitable organization, the capital gain will not be levied because the asset was donated in kind without having been sold until it was part of the trust. Since the charities which must be registered as 501(c)(4) non-profit organizations are the ultimate beneficiary of the donated assets, they are not subject to capital gains tax.

These are a few of the commonly used estate planning techniques that can help you minimize both their current and future tax liabilities, while still donating to a worthy cause of your choosing. Estate planning can be a very complex topic, and should be taken seriously. It is something that each individual should address with a competent estate planning attorney who is willing to work in conjunction with a tax advisor and a financial planner.

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