Life Policy broken down
Term policy is like renting an apartment, you get to use it for a specified time frame and when you leave you have nothing but 4 flights of stairs to carry your sofa down. All the Premiums went to the apartment complex with no refunds. However if you used your term policy the Apartment Complex will move everything and make sure your beneficiary has a place to stay.
Traditional whole life insurance policies have rigid rules which a policy owner must pay billed premiums no later than the end of the grace period or risk policy lapse. If you can maintain these rules you can have a guaranteed Death Benefit for life, and build cash value in the policy which can be taken as Cash or used for the purchase of more insurance. If you lapse the policy you get your Cash Value back. Should you at anytime decide to use the policy you are covered!
Universal Life, (UL – IUL)
Universal life insurance policies are characterized mainly by their flexibility in
·death benefits, and
·Access to cash value.
Universal life insurance is very different from traditional whole life insurance policies a universal life insurance policy owner can pay
·more than the billed premiums;
·less than the billed premiums;
Further, the policy owner may pay a premium at some time other than when billed.
Under a Universal Life Insurance Policy, the policy owner has complete freedom concerning how much premium to pay and when to pay it.
Universal life insurance represents a significant change from the traditional fixed premium whole life insurance products that preceded it. Earlier life insurance products were characterized by inflexibility in premiums, cash value, and death benefit. If the policy owner wants to reduce the premium for a whole life insurance policy, it is necessary to reduce the face value of the policy through a partial surrender of the policy. Unfortunately, this can result in the release of cash value to the policy owner and possible income tax liability. Universal life insurance policies unlock the connection between premiums, face amount and cash value.
Despite the premium flexibility, of universal life insurance, there are certain rules that apply to premium payments. Although a policy owner may choose to pay no premium into the policy on a particular premium-due date, any payments that are made must meet a certain minimum to help the carrier to manage the costs of premium collection and processing.
There are three premiums normally associated with universal life insurance policies:
The minimum premium is the premium that, if paid each year, would generally be just enough to keep the policy in force for one more year without the accumulation of any cash value.
The universal life insurance target premium is generally the amount of premium that will keep the policy in force for the insured’s lifetime. There is, however, no guarantee that the universal life insurance policy will remain in force for that period if only the target premium is paid. In fact, there is no guarantee that the universal life insurance policy will remain in force regardless of the premium level that is maintained by the policy owner.
The maximum premium is the largest permitted premium that will enable the universal life insurance policy to maintain its character as life insurance. If you pay additional premiums, then the policy will be considered a “Modified Endowment Contract” or MEC. MECs lose much of the tax advantages of life insurance.
No Lapse Guaranteed Universal Life Insurance Policies have a defined premium level at which the carrier guarantees that the policy will remain in force even if the cash value should dip below zero and the policy would otherwise lapse.
Universal Life gives you the flexibility to adjust the death benefit as your needs change, as well as the flexibility to pay smaller or larger premiums – depending on your financial circumstances. This is often an important feature for families who may have fluctuations in their ability to pay.
If your premium payments are too small for too long, the policy could lapse, leaving you without insurance protection. Also, if the insurance company does poorly with its investments, the interest return on the cash portion of the policy will decrease (but never below the minimum interest rate guaranteed in the contract). In this case, cash values will probably fall, forcing you to pay more premiums in the later years.
Uses for Universal Life
Creditor/Predator Protection. A person who earns a high income, or who has a high net worth, and who practices a profession that suffers a high risk from predation by litigation, may benefit from using Universal Life Insurance as a warehouse for cash, because in some states the policies enjoy protection from the claims of creditors, including judgments from frivolous lawsuits
- Final Expenses, such as a funeral, burial, and unpaid medical bills
- Income Replacement, to provide for surviving spouses and dependent children
- Debt Coverage, to pay off personal and business debts, such as a home mortgage or business operating loan
- Estate Liquidity, when an estate has an immediate need for cash to settle federal estate taxes, state inheritance taxes, or unpaid income in respect of decedent (IRD) taxes.
- Estate Replacement, when an insured has donated assets to a charity and wants to replace the value with cash death benefits.
- Business Succession & Continuity, for example to fund a cross-purchase or stock redemption buy/sell agreement.
- Key Person Insurance, to protect a company from the economic loss incurred when a key employee or manager dies.
- Executive Bonus, under IRC Sec. 162, where an employer pays the premium on a life insurance policy owned by a key person. The employer deducts the premium as an ordinary business expense, and the employee pays the income tax on the premium.
- Controlled Executive Bonus, just like above, but with an additional contract between an employee and employer that effectively limits the employees access to cash values for a period of time (golden handcuffs).
- Split Dollar Plans, where the death benefits, cash surrender values, and premium payments are split between an employer and employee, or between an individual and a non-natural person (i.e., trust).
- Nonqualified Deferred Compensation, as an informal funding vehicle where a corporation owns the policy, pays the premiums, receives the benefits, and then uses them to pay, in whole or in part, a contractual promise to pay retirement benefits to a key person, or survivor benefits to the deceased key person's beneficiaries.
- An Alternative to Long Term Care Insurance, where new policies have accelerated benefits for Long Term Care.
- Mortgage Acceleration, where an over-funded UL policy is either surrendered or borrowed against to pay off a home mortgage.
- Charitable Gift, where a UL policy is donated to a qualified charity, or the policy owner names a charity as the beneficiary.
- Charitable Remainder Trust Replacement, where a policy owner wants to replace assets donated to a Charitable Remainder Trust.
- Estate Equalization, where a business owner has more than one child, and at least one child wants to run the business, and at least one other wants cash.
- Life Insurance Retirement Plan, or Roth IRA Alternative. High income earners who want an additional tax shelter, with potential creditor/predator protection, who have maxed out their IRA, who are not eligible for a Roth IRA, and who have already maxed out their qualified plans.
- Term Life Alternative, for example when a policy owner wants to use interest income from a lump sum of cash to pay a term life premium. An alternative is to use the lump sum to pay premiums into a UL policy on a single premium or limited premium basis, creating tax arbitrage when the costs of insurance are paid from untaxed excess interest credits, which may be crediting at a higher rate than other guaranteed, no risk asset classes (i.e., Certificates of Deposit, US Savings Bonds).
- Whole Life Alternative, where there is any need for permanent death benefits, but little or no need for cash surrender values, then a current assumption UL or GUL may be an appropriate alternative, with potentially lower net premiums.
- Annuity Alternative, when a policy owner has a lump sum of cash that they intend to leave to the next generation, a single premium UL policy provides similar benefits during life, but has a stepped up death benefit that is income tax-free.
- Pension Maximization, where permanent death benefits are needed so an employee can elect the highest retirement income option from a defined benefit pension.
- Annuity Maximization, where a large non-qualified annuity with a low cost basis is no longer needed for retirement and the policy owner wants to maximize the value for the next generation. There is potential for arbitrage when the annuity is exchanged for a Single Premium Immediate Annuity (SPIA), and the proceeds of the SPIA are used to fund a permanent death benefit using Universal Life. This arbitrage is magnified at older ages, and when a medical impairment can produce substantially higher payments from a medically underwritten SPIA.
- RMD Maximization, where an IRA owner is facing Required Minimum Distributions (RMD), but has no need for current income, and desires to leave the IRA for heirs. The IRA is used to purchase a qualified SPIA that maximizes the current income from the IRA, and this income is used to purchase a UL policy.