Life Insurance Policies

Life Insurance

People typically buy life insurance to protect their survivors against the sudden loss of income and ensuring debts or estate taxes that may occur after the death of a breadwinner. Most seniors are past their employment years, so loss of income may not be a factor. However, seniors may wish to consider life insurance when faced with long-term care giving provided by an informal, unpaid family caregiver, such as a parent with a chronic illness or permanent disability depending on an unemployed adult child for assistance. Costs of replacing the services provided by an unpaid family caregiver may justify the need for life insurance on the care giver.

There are three main types of life insurance that are useful in protecting income and assets during retirement:

  • Term life insurance
  • Permanent life insurance
  • Life settlements and viaticals

Term Life Insurance

Term policies provide a specified death benefit, presuming the insured dies during the policy term. Terms may range from 1 to 30 years. Several insurances also are currently offering term life insurance with level premiums for the life of the contract. These typically are universal life policies. Term policies build no cash value, although certain policies can be converted at a later date to permanent cash value policies.

Premiums for term policies start out lower than for cash value policies, but increase with the insured’s age and deteriorating health. Premiums for insured seniors (65 and older) are typically so high that the insurance becomes unaffordable, causing people to drop the policies at the very time they are most likely to be needed. As a result, term policies should primarily be considered for temporary, rather than lifetime, coverage.

Permanent Life Insurance

Permanent life insurance policies provide a death benefit for as long as premiums are paid. Additionally, they usually feature a cash value that accumulates on a tax-deferred basis. Although the purpose of the cash value is to keep the premiums level for the life of the contract, it can also be used for additional purposes. For example, a policy owner may borrow the cash value for any reason, including additional retirement income. Various forms of permanent life insurance policies - including whole life, universal life, and variable universal life - offer different options for premium payment, adjustment of death benefits, and accumulation of cash value. Because a variable life insurance policyholder chooses the investment portfolio used to generate cash value, variable life is considered a security and must be sold by a professional holding a securities license.

Life Settlements and Viaticals

The emotional strain of anticipated death from a terminal illness or the stress of a seriously debilitating chronic illness is worsened by the customary increase in medical bills and the cost of the special care required.

Life settlements and viaticals may offer an option for turning life insurance into cash at a time when a senior most needs it – when the senior is terminally or chronically ill. Using life settlements and viaticals, a percentage of the face value of a permanent life insurance policy is paid by the funding insurance company to the policyholder in exchange for ownership of all or part of the policy. The policyholder and previously designated beneficiaries give up rights to the death benefit when the insured dies, in return for a tax-free settlement (Assuming Health Insurance Portability and Accountability Act of 1996 [HIPPA] and other federal guidelines are met) while the insured person is still alive. Third-party companies specializing in viatical and life settlements purchase the policy for less than face value. The investing company that purchases the policy pays future premiums to keep the policy in force and collects the death benefit when the named insured dies.

Viatical settlements may be available to policyholders who are chronically ill and have significantly shortened life expectancy. Life settlements, commonly called senior settlements, permit seniors who are 65 and older to exchange life insurance benefits for cash. Each insurance or life settlement company establishes its own criteria (which must be available to anyone seeking a settlement) regarding the policyholder’s life expectancy and the policy value. The vatical market expanded rapidly among the AIDS/HIV positive population, who experienced notoriously severe disability and financial devastation. Today it is used by individuals with a range of chronic, progressive, and fatal illnesses such as Lou Gehrig’s disease, cancer, and heart disease. While certain viatical settlement companies will accept a relatively long life expectancy, most prefer a shorter term.

Money distributed as an accelerated benefit or viatical settlement in conjunction with a terminal illness may be used by the recipient for any purpose. Typical uses for such distributions include the following:

  • Greater income
  • Out-of-pocket medical expenses
  • Alternative treatments not covered by traditional medical expense insurance
  • One last dream vacation
  • Loan payoffs
  • Cash gifts to loved ones
  • Charitable gifts
  • Dignity earned from not dying destitute

Risk management and insurance planning can go a long way toward increasing a senior’s financial comfort and provide more of a sense of security. Good planning in this area will also help seniors hold onto their assets through the proper use of insurance.

Holding onto assets, however, and improving income can create another problem: taxes. The United States has a graduated income tax that, in simplified form, means the more income an individual has, the more opportunity there is to pay more taxes.

Providing Cash to Pay for Estate Taxes

Some seniors think that life insurance benefits are tax-free, so they purchase them to provide an inheritance for family members or others. But tax-free means only that the beneficiary does not have to pay income taxes on the proceeds that are paid after the insured person dies.

What many individuals do not realize is that life insurance can increase their estate taxes, because the often-substantial value of a life insurance policy is included in a taxable estate. Life insurance can be the asset that pushes an estate's value over the decedent's applicable exclusion amount and into a situation of owing estate taxes.

However, it is possible to exclude a life insurance policy from the taxable value of an estate by making the heirs the owners of the policy, or by creagin an irrevocable life insurance trust (ILIT) with the heirs as its beneficiaries.

A properly established irrevocable life insurance trust provides an inheritance and funds to pay anticipated estate taxes. For example, it may be distasteful to some individuals to think of being forced to quickly sell a large portion of their assets in a business or real estate to pay federal estate taxes. But if they place these assets in an irrevocable life insurance trust, it allows them to pass on intact estate to their heirs without liquidating a portion of it to pay estate taxes. Also, if an individuals estate is close to or will exceed the applicable exclusion amount, it makes sense to create an irrevocable life insurance trust to remove assets from the taxable estate, assuming the policy premiums are less than a paying the estate taxes.

Seniors who are considering an irrevocable life insurance trust are advised to seek guidance from an estate planning attonrye who can ensure this trust is properly crafet to prevent it from being included in teh decedent's taxable policy-such as the abiliti to borrow against cash value or change beneficiary designations-the life insurance policy will be included in theestate. And, because the senior cannot change an irrevocable trust after it is created, it is important to carefully consider his or her futrue needs and goals at the time the irrevocable life insurance trust is established.

In addition, married couples can take advantage of a second-to-die (survivor) life insurance policy. This policy pays at the second death when estate taxes are due, but usually costs less than buying a separate life insurance policy for each spouse. Second-to-die life insurance policies may be available even when one spouse is uninsurable.

The information above is reprinted from Working with Seniors: Health, Financial and Social Issues with permission from Society of Certified Senior Advisors® . Copyright © 2009. All rights reserved.