Category: Types of Insurance

The Many Uses of Life Insurance

Life insurance is perhaps one of the most misunderstood and under utilized forms of insurance.

Most people are aware that life insurance can serve as an effective financial replacement for loss of income when a loved one dies. but it is so much more than that. Structured appropriately, life insurance can protect an estate, provide tax free income for retirement, protect a business, and be used by a business to attract and keep quality employees.

The variety of life insurance uses can best be understood by looking at two different buckets, personal uses and business uses.

Personal

Most people understand the basic concept of income replacement, but often avoid it since it involves talking about death. A more positive way to look at it is you are giving your loved ones the opportunity to live. Looked at this way, the topic isn’t so depressing. To provide this opportunity to your loved ones you need to consider how well you want them covered and how long you want the income replacement to last. A professional insurance/financial advisor can help with this

Two other uses of life insurance for individuals are protecting an estate and securing supplemental tax free income in retirement. These two applications are more complex and so it is best to consult with your financial advisor and tax advisor as well as in the case of an estate, your attorney.

Life insurance protects an estate in two ways. Because proceeds are tax free, you can use them either as direct inheritance in lieu of other taxable means of inheritance, or in the case of cash value policy you can use the cash value to meet the tax demands of the estate. Again, each individual situation is different and it is best to get advice from your financial advisor.

Using a cash value life policy to fund a tax free retirement is one of the most creative and fun uses of life insurance. Because life insurance is favored by the IRS, it is possible to use it like an unlimited ROTH and grow and access accumulation of wealth tax free. For more detail on this feature of life insurance I highly recommend Tax Free Retirement by Patrick Kelly.

Business

Because they operate as entities, businesses can use life insurance in similar ways to individuals. The most common uses are protecting the business from a significant death and rewarding employees.

Businesses need protection from the loss of key employees as well as be safeguarded from loss of a managing partner. Protecting a business from the loss of a key employee is much like protecting a family from the loss of the breadwinner. Instead of having individual relatives as beneficiaries, the corporation or a representative thereof is the recipient of the proceeds and then they are used to replace that loss.

In the case of joint ownership, the owners can fund a buy-sell agreement using life insurance. This is a more complex process depending on the size and value of the business and the number and stake of the partners. It is best not only to have an insurance professional but a legal professional to help ensure things are set out in a proper manner. The thrust behind this insurance is that the remaining partner can buy out the heirs of the deceased partner, and therefore continue the business using the life insurance.

Businesses can also utilize cash value life policies to attract and maintain valuable employees through the executive bonus plan 162. This is based off of section 162 in the IRS tax code and is unqualified money, meaning there are a lot fewer restrictions legally and more freedom for the business.

The Umbrella

One of the most useful but often overlooked policies is the umbrella.

The umbrella policy is often compared to a security blanket. It sits over your existing coverage to provide extra protection in case all hell breaks loose. What a lot of people don’t realize is how flexible an umbrella can be.

Umbrella policies come in all shapes and sizes just like their physical namesakes. Most start at $1,000,000 and can get as big as $10,000,000. They also have a range of purposes like covering personal assets up to covering multi location businesses. Some umbrella policies sit over both for broad protection.

What a lot of people don’t realize about umbrella coverage is that it can be for more than just liability coverage. Although its primary purpose is to extend liability protection it can also be used as an extension of your personal protection.

For example in automotive coverage it is generally a good practice to have uninsured motorist protection to cover you if you are hit by someone without insurance. The umbrella can expand this coverage, usually for additional premium. Some business umbrellas have endorsements that extend them over things other than strict liability as well.

To understand the value of the umbrella, I’ll tell you a story that I heard from a colleague of mine. There was a farmer who was getting close to retirement and his farm, worth 1.5 million, was his retirement plan. One evening a gate was left open on his property. Early the next morning one of his cattle bolted across the highway and slammed into an SUV with a family of 5, all of whom sustained significant injuries and sued for their bills and to replace their totaled car. The car spun out and significantly damaged fencing on the neighbors property as well. The farmer did not carry an umbrella and only had 1 million on his farm. Total court costs and damages came to over 3 million. For lack of an umbrella he lost his farm, lost his cash savings, and was unable to retire as planned.

A basic 2 million umbrella probably would have cost him under 1000 per year and would have helped save the farm and his retirement. There are many more examples like this. Moral of the story is, if you have assets protect them.