The Life Insurance Buyer's Guide will not help you lower your cholesterol, stop smoking; lose weight, lower your blood pressure, or learn how to calculate why the gross premium for a $100,000 traditional whole life-insurance policy paying dividends as declared for a 45 year old nonsmoker, nonunisex rate is $2001. It will, however, give you straight talk on three important areas of your life, all of them affected by money: death, dissability, and retirement.
-- Reading-this-book from cover to cover and putting what you learn into practice will help you to make sure that:
• Your family will continue to live in the fashion to which they have become accustomed (if that is what you want) when you die.
• Your business interests will not go down the drain because of some misunderstanding or lack of money.
• If you become disabled, you will be able to contin ue to live in the fashhion to which you have become accustomed.
• You will be able to retire or slow down with dignity, because you will have enough present-value money.
a variety of terms, expressions, and statements will be defined throughout the book. The definitions that I will give are based on my 'expe,!ience in life insurance and financial services, beginning in 1958 . . As su'ch, these definitions reflect n'One of the textbook complexity or professional doubletalkail too common in today's marketplace. What you will read here is commonsense straight talk about financial subbjects-straight talk that will help you to understand financial matters that have become extremely complicated with the growth of financial services industries through the years.
Capital Formation
The objective of life insurance is not to make you rich, but rather to make sure that you and those important to you neveLbe<::Qme poor. The time-honored definition of life insurance is that it provides for a stipuulated sum to be paid to a designated beneficiary upon the death of the insured. In a very real sense, life insurance is capital formation.
Capital is usually defined as ithe value of accumulated goods which devoted to the production of other goods, and accumulated possesssions calculated to bring in income. Formation is defined as an act of giving form or shape to something, or of taking form.
After an insured person dies, capital is formed when the death bennefit (the face amount of the life insurance policy) is paid to the benefiiciary. The initial value is the death benefit. The value can be used to produce other goods or to bring in income depending upon how the beneficiary decides to use--it.
Unlike other ways to create capital (e.g., regular savings, investing in a mutual fund, or investing in a business), life insurance chiefly forms capital when the insured dies. But, depending upon the type of life innsurance, capital may be formed without the insured having to die-e.g., by borrowing against the cash reserve (cash-surrender value) of an innsurance policy, or by using paid-up dividends (paid by an insurance company on a policy that is fully paid up) to provide a capital stream of Income.
Looking upon life insurance as a vehicle for capital formation will alllow you to determine whether it is the proper vehicle for you LO use l create capital for your own specific needs-needs which could take the form of protection for your family, protection for a business obligation, or provision of supplemental retirement income to yourself, just to name a few of many possibilities.
This discuss in depth the various types of life insurance that are available. In this chapter we simply address the issue of whether ~.' pr not these various types of insurance can be used as a vehicle for cappital formation while the insured is still alive.
Term Insurance
. When you buy term insurance, you buy only protection. There are no living benefits from term life insurance because there often is no cash reserve building up. As a result, there usually is no cash-surrender value, and capital cannot be formed before the insured dies.
Traditional Whole Life and Graded Premium Life Paying Dividends as Declared
With a traditional whole life and graded premium life policy paying diviidends as declared, you can borrow from the policy's reserve (its cashhsurrender value). No taxes become due on such a borrowing because it is considered a loan, provided that, for all types of nonterm life insurance issued on or after June 21, 1988, the seven-annual-premium-payments test is met. The dea~h benefit, however, is reduced by the amount you borrow. This reduction is made because the reserve is the amount of money the insurance company has set aside to meet death claims. The insurance commpany carries the reserve as a liability, not as an asset on its balance sheet. When the reserve is borrowed out, the insured has received (as a loan of money) a portion of the death benefit in advance. Interest is charged on the loim because when the insurance company calculates the premium to charge and projects dividends, it must take into consideration:
• Mortality expenses
• Business overhead expenses
• Interest the company can earn on money coming into the store (preemium payments)
Because the reserve is borrowed out, the insurance company can no longer earn interest on it. As a result, it must charge interest to make up the difference.
Money can also be received as a living benefit without borrowing if
thepolicy is put.on a p~id~up basis. For example, it takes X dollars of reserve at each age to-payup$1000 of insurance. Once paid up, the reserve increases each.y~ar, and in addition, the insurance company may pay it paid-up divi~knd (though this is not guaranteed). The paiddup dividend, in addition to the reserVe increase, represents the interest the insurance company is paying to the insured on the money used to pay up the insurance. The paid-up dividends are tax-free until they exxceed what the policy cost, which is the cumulative sum of the premiums paid. The reserv~ increases on a tax-exempt basis because it is part of the paid-up death benefit.
Asa life insurance purist, I believe it is best never to borrow indisscriminately agaiilstthe cash reserve of an insurance policy, because:
• Borrowing destroys all the equity within the policy; borrowing on a life insurance policy is similar to refinancing the mortgage on a house.
• Borrowing forces you to pay interest which is nondeductible for fedderal tax purposes, according to the Tax Reform Act of 1986.
What you have just read about the effe<;:ts of borrowing and interest for traditional whole life and graded premium life paying dividends as declared also pertains to all other nonterm life insurance policies-i.e., interest-sensitive whole life, universal life, variable life, and universallvariable life. Ask the person responsible for your life insurance for a detailed explanation of the seven-annual-premium-payments test, as mandated by the 1988 Technical Corrections Act, and its effect on livving benefits via loans or withdrawals.
Interest-Sensitive Whole Life
Since an interest-sensitive whole life policy pays no dividends, the only way to get living capital formation benefits from interest-sensitive whole lifelsio Darrow againsCthe reserve, i.e., the cash-surrender value.
Universal Life
Any withdrawal from a universal life policy should be tax-free unless it is in excess of premiums paid. A withdrawal is not a loan. You can also take a loan against the reserve, i.e., the cash-surrender value, of the pollicy to get living capital formation benefits from universal life_
Variable Life
Since most variable life policies pay no dividends, the only way to get living capital formation benefits from variable life is to borrow against
- Historically, the life insurance company from which I purchased my life and disability income insurance is not number I in terms of lowest costs. The contractual ingredients within its policies are, however, excellent. These provisions, combined with the company's proven track record of treatihgair policyholders the same (i.e., making new benefits retroactive "to existi!1g policyholders) and its fairness, common sense, and com pas-
sionwhen a. claim arises, make the company attractive to continue to do
-business with. -
But, you may well ask, when it comes to choosing life and disability
_ " insurance, how does this author know that design, trust, and service are more important than price? The answer is that I know because on January 18, 1986; I 'almost died. Since that date, I have had seven hosspital 'admissions, two surgical operations, and one medical-surgical proocedure. My "brand-name'.' life and disability insurance policies have doneancl will continue to do their job. Even though I had sold these
. policies-for-many years and had believed myself to be highly knowlledgeable on the subject of life and disability insurance, I did not fully appreciate what my policies could and would do for me and my family, nor how truly v~luable they are, until I myself almost died and did beecome disabled. Here is what they have done:
-My disability insurance has enabled me to go on living in the fashion , to .whiCh I had become accustomed, and I will continue to be able to ~live-irf:fIiiancial comfort if I remain either totally or residually diss. . abled.(Refer to Chapter 19 for discussion of the importance of dissability insurance.)
- My disability insurance has enabled, and will continue to enable, my family to go on living in the fashion to which they had become accusstomed.If I should die, my life insurance will enable them to continue to live as comfortably as they do now.
• When I am ready, my disability insurance will allow me to retire With dignity. It is sufficient so that my retirement plans (i.e., Keogh, IRA, and a pension plan through a life insurance company) can remain unntouched and continue to grow, tax-deferred. In addition, the premiums on my life and disability insurance are waived
for an explanation of waiver of premium), thus not creating a current cash- ow problem. Finally, my type of life insurance...,-traditional whole life pa ing dividends as declared (refer to Chapter 13)--in addition to providing a constant paid-up death benefit starting at age 65 and conntinuing for the rest of my life; also provides supplemental income in the form of paid-up dividends, also starting at age 65.
Summary
. You should investigate whether or not your insurance company has a complete menu of insurance products available. If it does, you should consider exchanging interest-sensitive whole life, universal life, and variable life for paid-up whole life so that you can have a policy that features paid-up dividends-in the event that your own specific circummstances may require supplemental retirement income.
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