The D.I.M.E.+ Method

In this method of determining the Face Amount for a life insurance policy, four basic financial components are used to determine what level of coverage is needed in order to protect your family in the untimely event of the loss of a bread winner.

• Debt - Obtain the total amount of debt that you have including auto loans, credit cards, student loans, personal loans and other financial obligations.

• Income - Take your current income and multiply it by the number of years that you would need your family to benefit.

• Mortgage - Add up all mortgage balances.

• Education - Estimate the future cost of a 4-year college education and multiply by the number of children that you have.

• + Retirement - Total dollars needed for retirement.

It's clear that in this scenario, life insurance is essential. If the primary breadwinner were to pass away prematurely, the impact would be devastating, with a mortgage balance, debts to pay, income to replace, and two children's education to fund. 

However, the prospect of needing over $1.5 million in life insurance coverage may seem daunting and costly at first. Fortunately, this is where Term Insurance can be helpful. 

          MORTALITY CHARGE

• Insurance companies use a Mortality Table to determine the Cost of Insurance (COI) per $1,000 of coverage. This table takes into account various factors such as age, gender, smoker/non-smoker status, height, weight, and medical history to determine life expectancy. 

• The amount charged by the insurer to provide life insurance coverage to the policyholder, called the Mortality Charge, is based on this data. 

• As a person ages, their chances of death increase, resulting in an increase in the COI each year to ensure the coverage of their life. 

TYPES OF INSURANCE

TERM INSURANCE: Check the Term Life Page for more details

     PERMANENT INSURANCE

Also called Cash Value Life Insurance, there are various types of permanent life.

Characteristics of all Permanent Life

Designed to stay in force for the insured's lifetime.

Based on age 121 (most states).

Premiums are higher than term insurance in the earlier years.

All permanent policies build cash value, even if it is minimal.

Cash Value grows tax-deferred

Withdrawals & Distributions are tax-free (conditions apply)

Protected from creditors and lawsuits (varies by state) 

1.  Whole Life

Sometimes referred to as Ordinary Life or Straight Life, Whole Life insurance gives you guaranteed cash value amounts, guaranteed Cost of Insurance and a guaranteed death benefit. The basic idea of Whole Life is that the cash value and interest built up in the earlier years will offset the increased internal cost of insurance in the later years.

• Premiums are fixed and guaranteed.

• Face Amount is fixed and guaranteed.

• Generally Whole Life is the most expensive form of life insurance.

• Death benefit is the face amount only. You do not get both the face amount and the cash value.

Limited Pay Whole Life

These types of policies accelerate premiums into 10, 15 or 20 years; or they are accelerated to pay only up to age 65. Such policies have much higher premiums, however other than the compressed premium payments, they function essentially the same way that traditional Whole Life policies do.

Single Premium Whole Life (SPWL)

Single Premium Whole Life policies are a popular choice to pass assets to a beneficiary and completely eliminate estate taxes or probate. As mentioned earlier in this book, life insurance creates wealth out of thin air. Imagine being in your 70s and having the ability to turn $100,000 of cash in your bank account, that would normally be taxable and subject to estate taxes or probate, into a guaranteed estate tax-free and probate-free death benefit of $140,000. You can do this with the magic of life insurance.

2. Universal Life

Universal Life (UL) is similar to Whole Life but offers flexibility. Universal Life gives you the ability to increase, decrease or skip premium payments, providing there is enough Cash Surrender Value in the policy to pay the Cost of Insurance and other policy expenses. You can also increase or decrease the death benefit. Interest rates may fluctuate based on economic conditions, however many policies offer a guaranteed minimum interest rate.

These policies generally allow you to choose one of three potential Death Benefit Options:

Option A - Level Death Benefit. This is for those seeking faster cash value accumulation. The underlying term insurance acts like decreasing term insurance, so as the cost of insurance increases each year, the amount of the insurance premium allocated to the COi stays the same, allowing the same amount of contributions towards the cash value to remain constant each year.

Option B - Increasing Death Benefit. This is for those that want the death benefit to be a combination of both the initial death benefit plus the cash value. On the surface, this may seem to be the best choice, however it depends on the goal of the insured. The underlying term insurance acts like annual renewable term insurance, so as the cost of insurance increases each year, the amount of the insurance premium allocated to the COi increases, resulting in less of the premium going towards the cash value each year. This can be especially dangerous if a policy is minimally funded and interest rates remain low, particularly as the insured gets older and the cost of insurance drastically increases. Policies that have an Option B selection should always be overfunded to avoid such risk

Option C - Return of Premium. This option functions like an Option A plus a return of all premiums paid, net of any policy loans or withdrawals.

3. Variable Life

This type of insurance is similar to Whole Life, however in a Variable Life (VL) policy, cash value is actually invested in underlying mutual funds. These mutual funds are housed in a sub-account where an insured will have various sub-accounts to choose from. The cash value has the potential to grow as the market grows, however, just as in investing in mutual funds directly, the cash value may lose value.

With Variable Life, you lose the guarantees of Whole Life. In fact, even the Death Benefit can be less than originally purchased if the value of the cash value loses value. Some Variable Life policies will have a Minimum Guaranteed Death Benefit as a provision in the policy. Premiums are generally not fixed, meaning that you can increase or decrease premiums, however reduced premiums in a down stock market could compromise the status of the policy. As the cost of insurance increases and interest rates decline, it is possible that the premium payments are not enough to satisfy the COi and expenses of the policy. When this occurs, the additional funds will automatically be deducted from the cash value. With a continued negative performance, the insured may be forced to significantly increase premiums, or the policy may potentially lapse.

In order to purchase a Variable Life policy, you will need to find a life insurance agent that has both a life insurance license and a securities license (Series 6/63).

4.  Variable Universal Life

Variable Universal Life (VUL), as the name implies, is a combination of Variable Life and Universal Life, giving you the best of both worlds. You can choose one of the Death Benefit Options (A, B or C); invest the cash value into mutual fund subaccounts; increase, decrease or skip premium payments; and increase or decrease the Face Amount of the policy.

As with Variable Life, you will need to find a life insurance agent that has both a life insurance license and a securities license (Series 6/63) in order to purchase a VUL policy.

5. Indexed Universal Life

Indexed Universal Life (IUL) is one of the hottest insurance products on the market right now. It takes all of the benefits ofVUL and adds a degree of safety to the cash value by allowing the cash value to be allocated into Indexed Accounts, which allows you to indirectly participate in the success of the stock market index, while avoiding the risk that is associated with a loss in the stock market index.

In order to purchase an Indexed Universal Life policy, you will need to find a life insurance agent that has only a life insurance license, since there are no underlying securities.

LIFE INSURANCE RIDERS

You may add additional features and benefits to your life insurance policy by adding a rider. A rider is usually a feature that is provided at an additional cost, however some riders may be free and automatically included. Below is an example of some of the most common riders:

Guaranteed Renewability

Term Insurance only. This allows a policy the ability to renew at the end of the term and pay the actual cost of insurance as already stated in the policy regardless of the insured's insurability. This is usually a no-cost rider and is automatically included on most modern term insurance policies.

Guaranteed Convertibility

Term Insurance only. This allows a policy the ability to convert all or a portion of the term insurance Death Benefit into permanent insurance, regardless of one's insurability. This is usually a no-cost rider and is automatically included on most modern term insurance policies.

Waiver of Specified Premium

All Policy Types. In the event that a policyholder becomes disabled for 6 months or more, this rider will pay for the actual premium that the insured is scheduled to pay. For permanent insurance, this will allow cash value to continue to grow. This rider usually expires at age 65.

Waiver of Monthly Deduction

UL/VL/IUL. In the case that a policyholder becomes disabled for 6 months or more, this rider will pay only for monthly deductions (Cost of Insurance and Policy Expenses) that the policy incurs. It will not add premium to the Cash Value. This is a less costly option for Permanent Insurance than the Waiver of Specified Premium. This rider usually expires at age 65.

Paid-Up Additions

Permanent Policies Only. For a mutual insurance company that pays a dividend, you may have the dividends purchase an additional paid-up Death Benefit.

Lifetime Income Option

Permanent Policies Only. This rider allows the insured to take a specified guaranteed lifetime income for the remainder of their life. Once an insured has elected thisoption, they usually may not make any additional premium payments to the policy. One of the great benefits of this rider is that it functions similar to an annuity; however, it has the tax advantages that only life insurance can offer.

LIFE INSURANCE LIVING BENEFITS

Life Insurance has typically only provided a payment of a claim upon the death of the insured. Living Benefits, sometimes called Accelerated Benefit Riders, is a relatively new feature that is added to some life insurance policies that allow the insured to place a claim against their policy while they are alive for a qualifying Chronic, Critical or Terminal Illness.

Chronic Illness

Usually defined as losing 2 or more of your Activities of Daily Living (AOL): Bathing, Dressing, Toileting, Transferring, Continence, Eating; or a severe cognitive impairment such as Alzheimer's disease and Dementia.

Critical Illness

Usually defined as one of the following conditions: Major Heart Attack, Stroke, Major Organ Transplant, Coronary Artery Bypass, Invasive Cancer, End Stage Renal Failure, Paralysis, Coma or Severe Burn.

Terminal Illness

The definition of a terminal illness generally refers to a condition that is incurable and cannot be adequately treated by a physician, and is reasonably expected to result in the insured's death within 24 months (12 months in some states) from the date of diagnosis.

Now, picture being able to make a claim against your life insurance policy if you are diagnosed with such a condition. Policies that come with this rider are often referred to as "Life Insurance That You Don't Have To Die To Use."

Living Benefit awards that come with this type of policy can be used for anything, unlike Long-Term Care insurance, which has premiums that increase with age and only covers approved reimbursement expenses. This benefit can be used to pay off your mortgage or auto loans, buy groceries, pay for healthcare, travel, or any other expenses you may have. It is not coordinated with any other healthcare and may be tax-free, subject to current IRS regulations.

 FACT: Living Benefits are available on both term and permanent insurance policies.

LIFE INSURANCE TAX ADVANTAGES

The IRS defines what is considered life insurance policy based on two criteria, providing the policy was placed in force after June 20, 1988:

1. It must meet the statutory definition of life insurance; and

2. The policy must meet the requirements of the Technical and Miscellaneous Revenue Act of 1988 (TAMRA) 7-paytest.

If it does not meet the above qualifications, it is considered a Modified Endowment Contract (MEC) and it will lose many of its tax-advantages.

Tax-Free Death Benefit

Upon death, the death benefit, including any applicable cash value, is passed to the named beneficiary income tax and estate tax-free. Cash Value in a life insurance policy is not part of an insured's estate and will bypass probate court.

Tax-Deferred Earnings

Earnings in a permanent life insurance policy are generally not taxable. A taxable event will occur if the policy is surrendered or lapsed, and the proceeds returned are in excess of the cost basis (the total of the premiums paid) of the policy.

Tax-Deferred Withdrawals

Your cost basis can be withdrawn tax-free, as this was already paid with After Tax dollars, providing there is available cash surrender value.

Tax-Deferred Loans

It is possible to withdraw policy gains as a Policy Loan, which will remain tax-free if the policy remains valid for the insured's lifetime. 

When a policy loan is taken, the insurance company will charge an interest rate for the borrowed amount. Some Universal Life policies offer zero-cost or wash loans, which means that there are no costs associated with these loans. 

Additionally, variable loans are available, which enable the cash value to continue earning interest while the policy loan is outstanding. 

BUY TERM AND THE REST IN PERM

Here are the main points of the strategy of using a fully-funded permanent insurance product instead of a Qualified Plan or annuity when practicing the Buy Term and Invest the Difference approach:

1. The strategy provides high term insurance living and death benefits to cover the insured during the years when they need it the most.

2. Ideally, purchase a term policy that expires close to your 65th birthday.

3. Instead of investing the difference in a Qualified Plan or annuity, use it to buy a fully-funded permanent insurance product, such as an IUL. The permanent insurance product is designed to accumulate cash value rather than to serve primarily as an income replacement tool. Using an IUL with an Option A Death Benefit Option usually keeps the policy expenses low.

4. Since the IUL is fully-funded, additional premiums cannot be added without making the policy a Modified Endowment Contract (MEC). If you want to make additional contributions to a fully-funded IUL, use the Guaranteed Convertibility rider on your term insurance policy to increase the death benefit on the IUL. This will allow you to contribute higher premiums.

5. Any Living Benefit claims while the term insurance policy is in force should be made against the term insurance policy, not the permanent policy. This will ensure that the cash value in the permanent policy remains unaffected.

6. The cash value in the permanent policy is protected from creditors, lawsuits, and other claims.

7. The cash value is excluded from your estate, and upon death, can pass to your named beneficiary as an income tax and estate tax-free life insurance benefit.

8. Most importantly, this strategy offers the opportunity for a tax-free retirement.