What is the real purpose of whole life insurance?  Hint: it’s not to insure your life.

Answer: the best use of whole life insurance is to avoid estate taxes.

Whole vs. term life insurance

Term life insurance is a contract that, if you die during a specified period of time, your beneficiary will receive a sum of money (the death benefit).  After the term expires, the contract is worth nothing.

Whole life insurance will also pay your beneficiary a sum of money, in the event of your death, but in addition, the policy accumulates a value.  Part of your monthly (or quarterly or annual) payment goes towards the actual term life insurance portion of the contract.  The rest of the payment goes into an investment, depending upon the type of policy.  The investment builds up value over time.

If a policyholder terminates the contract, he can receive the “surrender” value of the policy.  In the early years of the contract the surrender value can be negligible, but the value rises in later years.

Irrevocable life insurance trust (ILIT)

To avoid estate taxes, you can create an irrevocable life insurance trust (ILIT) to own the policy.  This transfer the funds out of your estate and into the trust’s.  It lowers the value of your estate, and should you die, it reduces your potential estate tax bill.

Estate taxes

In 2009, estate taxes were as high as 45%; however, the exclusion was $3.5 million.  If your net worth was less than $3.5 million (which includes >99% of Americans), you did not owe any estate tax.  That is why whole life insurance (and ILIT’s) are only useful for the rich.

2010 is kind of a crazy year for estate taxes, because this year you get an unlimited exclusion — there essentially is no estate tax this year.  All bets are off for 2011.  Unless Congress acts, the estate tax will be reinstituted and the exclusion will drop to $1 million, subjecting a much larger percentage of Americans to estate taxes.

Boy, that sounds a lot like how the Alternative Minimum Tax (AMT) crept from the wealthy into the middle class.

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Tags: ILIT, life insurance, term life insurance, whole life insurance

One of the perks of employment used to be that your employer would provide you with 1x or 2x your salary in life insurance.  Today, many employers trim expenses by reducing the amount of life insurance given as a benefit.  Employees are instead offered the opportunity to purchase additional insurance through the company’s group life insurance program.  But is it a good deal?

Are we talking term or whole life insurance?

Term life insurance is a straightforward contract:  “If you die during the period that the contact is in effect, your designated beneficiary will be paid the death benefit”.  Whole life insurance is a completely different ball of wax.  Whole life insurance is an investment vehicle to help the rich avoid estate tax.  (Yes, really).

So, we’re talking term.

A term policy has level payments, meaning that the premium (what you pay each month) is predetermined and never rises for the term of the policy.  In addition, most term policies can be extended (converted), albeit at a much higher premium.  This might make sense if you are stricken with terminal cancer in the 19th year of your 20-year term policy.  With cancer, you would not pass a medical exam for a new life insurance policy, but you might choose to convert your existing term policy.

Who needs life insurance?

Do I need life insurance?  Easy answer:  No.  You don’t need life insurance — it’s the people you leave behind that do.  The purpose of life insurance is to help your dependents cope financially should you die prematurely.

If you’re single and have no children, who would be affected by your death?  Unless you’re the primary support for a disabled sibling or a parent, then you probably don’t need life insurance.

If you’re married, your spouse works full time, and you have no children, you still may not need life insurance.  If you and your spouse agree that you could each maintain your standard of living without the other’s financial support, then you probably do not need life insurance.

If you have a child (or children), then you need to plan how these dependents will be financially supported.  You might plan to support a child until able to provide for him/herself, perhaps at age 18, 21, or 25.

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Tags: employee benefits, life insurance

Today I received an invitation from my insurance company, USAA, to attend an educational session about long-term care insurance.  USAA is a terrific company, and I’ve been a happy customer for almost thirty years (yikes!).

I noticed a small typo on the invitation that unintentionally (I assume) besmirches their corporate partner.  Funny, I didn’t know I needed “lie” insurance.

Carnival: This post was included in this week’s Carnival of Personal Finance.

Tags: funny advertisements, John Hancock, typos in ads, unintentionally funny ads, USAA

“Dear Helen:

We recently bought a ten-year old house.  After moving in, we hired a carpenter to replace a warped window.  Upon removing it, he discovered that the surrounding wood was rotten.  Further investigation revealed that during the original construction, the flashing at the roofline had been installed improperly.  When it rained, instead of running down the outside of the clapboards, water ran down between the clapboards and the foam insulation, rotting the wood.  In addition, one rotted post in the attic had become home to a family of carpenter ants.  The total cost of repairs raised the price of an expected $1500 job into over $10,000!

Our home insurance won’t cover the damage, since the only coverage for rot is when it is caused by a single event and not gradually over time.

Is there any other way to recoup some of this unplanned expense!?”

– Rotten Luck Read the rest of this entry »

Tags: home insurance, tax deduction, termites