Monday, November 08, 2010

Life Insurance questions from readers like you

Q1) Here is a question that was ask to the public on Yahoo Answers:

I can no longer afford the 325 a month for whole life insurance. I have approximately 25K cash value. I can get a term policy for around 225 a month. Do I lose the 25K value? Can I have my dividends on the 25K pay my premium? It seems to have a pretty decent return. It says guaranteed rate of 4% return. Last years return
PremiumPayments $3,900.00
Total Additions $3,900.00
Cost of Insurance -$1,731.26
Total Withdrawals -$1,731.26
Change in Value
Fixed/ Variable Account Results $4,522.01
PremiumExpense Charges -$195.00
Total Change in Value $4,327.01
Ending Value $21,512.78

I need some serious help. I don't know what to do!

The policy is about 12 years old. My husband was the bread winner at the time this is no longer the case. The policy is for 350K he is 44 and a smoker. I get 3 times my annual income from my work for about 15 bucks a month (approximately 216K all together) . The 350K policy has a rider that covers me as well. I am 42 non smoker and pretty darn healthy.

ANSWER to Q1: You should get a 20 year level term insurance and add your husband as the spouse rider. With the information you given, it would cost about $200/month with $350k coverage on both of you (for a total coverage of $700k). After the term policy is issued, there are 2 things you can do with your whole life policy: 1) You can cancel your whole life policy and take the cash surrender value, which is cash value minus the surrender charge, or 2) do a 1035 exchange and move the cash surrender value into an annuity.

Annuity can pay a death benefit if you never touch the money or pay lifetime income when you begin withdrawing money. The death benefit for an annuity will always be the minimum of what you put in or the maximum value of the annuity. For example, if you put in $20,000 into an annuity and the value is $15,000, your death benefit is $20,000. If the value of your annuity is $30,000, then your death benefit is $30,000. When you start withdrawing money from the annuity, you lose the death benefit, but the annuity will pay lifetime income to you.

Are annuities right for you? I don't know your entire financial situation, so you have to decide that for yourself. In my opinion, annuities are good for people who are getting near retirement and have no retirement plan at all.

Here are some interesting information about whole life insurance in general:
1) You know its more expensive than term. When you were 30 and your husband was 32, it would of cost about $122/month for a 20 year level term, saving you about $200/month.

2) You know it already has low interest rate of 4%. If you saved the $200/month during the 12 years and invest it in mutual funds, which has an average annual return of 10.99% since 1980, you will have about $59k right now. Or with 8% return, about $48k. Are these interest rates guaranteed? No, but that how's the US stock market has historically perform over the long run.

3) If you want to take money out from it, you will be borrowing and paying interest rate of around 8%. With mutual funds, the money is yours. There is no such thing as borrowing.

4) If you die someday, the company keeps the cash value and pays the death benefit (unless your death benefit option in your policy reads option 2 or option B, then death benefit will include cash value). With term insurance, if you die during the 20 year term, your beneficiary gets both the life insurance and savings. If you die after the term, at least you will be leaving lots of money behind to your spouse.

Q2) If all the beneficiaries die before the insured does, what happens to the life insurance death benefit?

A2) The death benefit will go the insured's estate.

Q3) How is life insurance taxed?

A3) If you live in the United States, life insurance proceeds are generally not taxable. If your life insurance builds cash value and you want to cancel it, you are very likely that you won't owe any income tax on it. The reason why is that the total premiums you paid in is far greater than the value of the cash value. If you have taken a loan from the cash value and didn't pay it back and someday you cancel the policy, you will owe income taxes on the loan balance. If you die and the death benefit goes to your beneficiary, your beneficiary will not pay any taxes on the death benefit.

Q4) Buy Term Invest Difference vs Whole Life?
Its been decided that I'll need a total of $100,000 in life insurance. I am trying to pick between a 20 year term policy (TP) or a whole life policy (WL).

If I get the TP, the annual premium is going to be $133. If I get the WL policy,
the annual premium is going to be $2500 for 20 years.

Here is the WL option, Choosing to show only 5 years is for simplicity but premiums are annual.

year of policy is 5 10 15 and 20
age is 34 39 44 49
premium paid 2500 2500 2500 2500
cash surrender value is 6000 28000 66000 100000
death benefit 100000 100000 100000 100000

for term 20 yrs:
year of policy is 5 10 15 and 20
age is 34 39 44 49
premium paid 133 133 133 133
cash surrender value is 0 0 0 0
death benefit 100000 100000 100000 100000

What annual rate of return should I get so that I can indifferent between these two policies when
the term policy lapses in 20 years?

Thank you for the help in advance. I greatly appreciate it!

A4) By buying term insurance, you will be saving $2367/year. If you invest the difference in mutual funds for the next 20 years, with 8% return you will have about $121,280. I'm being conservative with 8% because the S&P 500 in the last 20 years has about 11% return. If your investment has 10% return, you will have about $150,000. With 12% return, you will have about $208,000. If you open a Roth IRA, your money will grow tax deferred and when you are 59 1/2 years old, you can take money out and pay no income taxes. There are many mutual fund companies out there and I can't tell you which ones are the best, but I can tell you what I own. I invest in a mixture of Van Kampen mutual funds and Legg Mason Partners mutual funds. I have a total of 5 mutual funds that I own.

If you die during the term, at least your beneficiary gets both the death benefit and whatever money you have saved. With whole life, if you die, your beneficiary only gets death benefit and the insurance company keeps the cash value. Even if you die after the term, at least you will be leaving money behind to your beneficiary. In 20 years, you probably won't need life insurance. You should have very little or no debts at all and if you have kids right now, they will be adults.

Q5) I'm thinking about stop paying for my life insurance. What should I be aware of?
A5) If its term insurance, your policy will lapse and you will no longer be covered. If its whole life or universal life, the cash value (if any) will be used as a loan to pay for the premiums. If there is insufficient cash value to pay the premiums, then the policy will lapse. Also, if there is any loan balance on the cash value, then you will be liable for income tax on the loan balance.

Q6) Why does my life insurance policy have surrender charge?
A6) It is in case if you were to cancel the policy early, the company can recover its loss of paying commissions and initial policy fees by imposing surrender charge on the cash value, if any. Its another reason why you shouldn't get life insurance that builds cash value. You are better off getting term life insurance, which will cost significantly less, and investing the difference.

Q7) If I commit suicide, will the life insurance company pay?
A7) If you commit suicide during the first two years of the policy, the life insurance will not pay death claim. They may or may not refund the premiums to your beneficiary. After the first two years, the insurance company will pay no matter how you die. Read your life insurance policy for exact information.

Private Mortgage Insurance (PMI)

What is PMI or Private Mortgage Insurance? If you are looking to buy a new home and unable to make a down payment of 20% of the home value, the lender will add PMI to your mortgage payment. PMI protects the lender in case you default on the loan. Under Homeowner's Protection Act of 1998, lenders are required to cancel PMI when your principal amount reaches 77% (for high risk loans) or 78% (all other loans) of the original purchase price. You have the right to cancel PMI when the principal amount reaches 80% of original purchase price, but certain restrictions apply such as you have never been late on payments or the value of your home has not fallen or there is no 2nd mortgage on the home.

Please note that loans obtained before July 29, 1999 are not protected by this act, but some lenders follow this law whether the loan is obtained before or after this act. In either case, if you want to cancel PMI early, send a request immediately when the principal amount reaches 80% of the original purchase price. Just remember that restrictions apply if you want to cancel at 80%.