Planning for your family’s future: Is your life insurance sufficient?

By: Kenneth H. Kinder and Rob R. Sparks

Review your life insurance

It is important to periodically review your life insurance to make sure that you have a policy that will stay in-force long enough to accomplish your estate planning objectives. Recent actions by the life insurance industry to increase costs associated with some policies make it very important to have your insurance reviewed.

Do you really need life insurance?

Life insurance should only be purchased to replace an income in the event of a death. Most of us buy life insurance to protect a spouse or children from the loss of our income at death. How much life insurance you buy should be determined by analyzing your assets and your financial needs such as income for a spouse, college funding, mortgages, etc. If you have a very large estate and will have to pay estate taxes, purchasing life insurance can be a valid way to help heirs pay those taxes.

Life insurance shouldn’t be purchased as a retirement savings strategy. Life insurance policies have internal costs that reduce what you could otherwise earn on your money. These charges include sales and administrative expenses as well as cost-of-insurance charges. The cost of insurance is the pure cost of providing the death benefit. As you get older, the cost of insurance increases. Even if your policy is “paid up,” cost-of-insurance charges are still being charged against the policy.

Variable life insurance policies allow for the cash value of a life insurance policy to be invested in selected mutual funds or other market-based investments. However, variable policies are extremely complex and carry very high expenses. And, the funds offered can be limited and can carry high loads and expenses.

Insurance salespeople will tell you that the cash value of your policy grows tax-deferred. While this is true, the cost of purchasing and maintaining the policy can greatly diminish the advantage of tax deferred growth. Traditional insurance policies like whole life and universal life pay dividends or interest in the low to mid-single digits. Much better returns – even factoring in taxes – can be had in low cost mutual funds.

Also beware of promises that the cash value can be withdrawn and used to fund retirement needs. This is only partially true. You can withdraw the premiums you paid into the policy but that withdrawal may come with a penalty and will reduce the dividend you receive. If you want to access the growth in the funds you paid in without paying taxes, you will need to take a loan on the policy. When you take a loan the insurance company is lending you your own money and holding your policy as collateral. Paying both loan interest and increasing cost of insurance charges during retirement can quickly deplete the cash value of your policy causing it to lapse.

Is your policy in danger of imploding?

When you do not have sufficient cash value in your policy to pay the premium or if you are unwilling or unable to pay the premium from your current assets, your life insurance policy will lapse. Two factors often contribute to a sudden decline in the cash value of a life insurance policy causing it to implode – decreasing dividends and interest rates and increasing cost of insurance charges.

Today, dividend rates are about half of what they were just ten years ago. And, interest rates on universal life policies today are typically at the minimum rate guaranteed by the policy which can be as low as 3 percent. One old-line insurance company saw its dividend decrease year-after-year from $8,000 in 2010 to just $300 in 2018. If you purchased your life insurance policy when interest rates were higher, your planned premium was likely based on a projection of a much higher interest rate. As the interest rate decreases if you do not increase your premium your policy will draw upon the cash value of the policy causing it to rapidly decrease.

Recently, life insurance companies have dramatically increased the cost of insurance charges on their policies. Some policies have experienced the doubling of cost of insurance charges. Of course, people are living longer. So, these increases are not related to the company’s mortality experience. Instead, cost of insurance charges are being increased to recoup past losses on the policies or even to induce older policyholders to surrender their policy.

These cost of insurance charge increases have resulted in several lawsuits. Recently Transamerica Life Insurance Company agreed to settle a class action for $195 million for increasing cost of insurance charges when the increases were not permitted by the insurance contract.

If you borrow on your life insurance policy you should beware of a problem called the “surrender squeeze.”  Your policy could be in danger of lapsing because of decreased interest or increased cost of insurance charges. If your policy does lapse, you’ll owe taxes on the amount of the cash value, including loans that exceed the premiums you paid into the policy. The policy may be too expensive to keep because of increased cost of insurance and if the taxes owed are high, too expensive to let lapse. That’s the “squeeze.”

What we can do.

The attorneys at Strauss Troy are not life insurance agents, and we are not going to try to sell you more insurance or ask you to switch your insurance to another company. What we can do is help you review your life insurance and assist you if there is a problem with your policy. We can also assist you in evaluating how your policy fits into your current estate plan to ensure that your objectives in providing for your family are met in the event of death.

If you have would like a review of your policy, please contact Kenneth Kinder at 513-629-9488 or Rob Sparks at 513-629-9417.