September is Life Insurance Awareness Month, making it a good time to ask an important question:
What role does life insurance play in your overall financial plan?
Most people understandably think of life insurance primarily for its death benefit. If you pass away, life insurance can provide money to the people you care about. That benefit can potentially help replace lost income, pay debts, cover final expenses, fund education, or simply provide greater financial stability for your family. But depending on the type of policy you own, life insurance may be able to do more than provide a benefit after your death. Certain types of permanent life insurance can accumulate cash value that may become another financial resource during your lifetime.
Term Life Insurance vs. Cash Value Life Insurance
At a high level, life insurance can generally be divided into two broad categories: term insurance and permanent, or cash value, life insurance.
Term Life Insurance
Term insurance is generally the simpler of the two. You purchase coverage for a specified period—such as 10, 20 or 30 years. If the insured dies while the policy is in force, the beneficiary receives the death benefit, subject to the policy's terms. Term insurance generally does not build cash value. Because of that, term insurance can be an effective way to purchase a larger amount of death-benefit protection for a particular period of time at a much cheaper price point. For example, someone might want additional coverage while raising children, paying a mortgage or during their highest income-earning years.
Permanent or Cash Value Life Insurance
Permanent life insurance is designed differently. Policies such as whole life, universal life and certain other forms of permanent insurance can provide a death benefit while also accumulating cash value within the policy. That cash value can potentially become a financial resource that the policyowner may access during his or her lifetime. Different types of permanent insurance accumulate cash value differently, and costs, guarantees, risks and policy features can vary significantly. That makes understanding the particular policy important before deciding whether permanent insurance is appropriate.
Life Insurance Isn't Always Just About What Happens When You Die
This is an area of life insurance planning that sometimes gets overlooked. Depending on the type of policy and how it is structured, permanent life insurance may potentially serve several purposes within a broader financial plan.
For example, life insurance may be considered for:
- Income replacement for a surviving spouse or family
- Paying off a mortgage or other debts
- Providing funds for children's education
- Estate and legacy planning
- Business succession or buy-sell planning
- Providing liquidity for beneficiaries
- Charitable or legacy goals
- Accumulating cash value that may be accessible during the policyowner's lifetime
That last item can make permanent life insurance particularly interesting in certain planning situations.
How Can You Use the Cash Value?
As cash value accumulates within a permanent life insurance policy, the policyowner may have the ability to access some of that value through withdrawals or policy loans. Depending on the policy, its tax status and how distributions are structured, cash value may potentially be accessed on a tax-advantaged basis. That money could potentially be used for many purposes. It might supplement retirement income, help with a major purchase, provide money during an unexpected financial situation, help fund education or simply provide another source of liquidity later in life. There generally isn't a requirement that policy loans be used for one particular purpose. However, this is where proper planning becomes especially important. Policy loans and withdrawals can reduce the policy's available cash value and death benefit. Interest may be charged on loans, and taking too much from a policy can affect its ability to remain in force. If a policy with outstanding loans is surrendered or lapses, there can also be tax consequences. So while tax-advantaged access to cash value can be an attractive feature, it shouldn't be viewed as automatically or universally "tax-free money."
What About the Death Benefit?
The traditional reason for owning life insurance remains extremely important. Life insurance proceeds received by a beneficiary because of the insured's death are generally not included in the beneficiary's gross income for federal income-tax purposes, although exceptions can apply. That can make life insurance an important tool for transferring money to the people or organizations you care about. It may provide funds when they're needed without requiring other investments or assets to be sold immediately.
Life Insurance Can Change as Your Life Changes
The amount and type of life insurance that made sense when you were 30 may not be the same coverage you need at 45, 55 or 65. Marriage, children, grandchildren, a new home, business ownership, retirement and changes in your financial situation can all affect your insurance needs. That's why Life Insurance Awareness Month isn't necessarily about buying another policy. It's about reviewing what you already have and asking whether it still fits your life.
Consider questions such as:
Who are my current beneficiaries?
Is my existing death benefit still appropriate?
How long will my coverage remain in force?
If I own permanent insurance, how is the cash value performing?
Do I understand the guarantees, costs and assumptions within my policy?
Could my existing life insurance play a larger role in my retirement, estate or legacy planning?
Life Insurance Should Fit Into the Bigger Financial Picture
Life insurance shouldn't be considered in isolation. The right type and amount of coverage depends on your income, family situation, financial obligations, existing assets, retirement strategy, estate-planning goals and many other factors. For some people, straightforward term insurance may provide the protection they need. For others, permanent life insurance with cash value may potentially address additional financial-planning objectives. And sometimes a combination of different types of coverage may be appropriate. The important thing is understanding what you own, why you own it and what role it is intended to play in your financial plan.
September Is a Good Time for a Life Insurance Review
Life Insurance Awareness Month provides a simple reminder to pull out those policies and take another look. Life insurance is ultimately about protecting the people and things that matter to you. But depending on the policy, it may also provide financial flexibility and planning opportunities during your lifetime.
At Shepherd's Way Financial, we believe financial planning begins with understanding what's important to you and then looking at how the different pieces of your financial life work together. If you haven't reviewed your life insurance recently, September may be a good time to start the conversation.
Important Disclosure
This material is for general informational and educational purposes only and is not intended as individualized investment, tax, legal or insurance advice. Life insurance policies contain fees, expenses, limitations and exclusions. Policy loans and withdrawals reduce a policy's cash value and death benefit and may have tax consequences. Guarantees are subject to the claims-paying ability of the issuing insurance company. Tax treatment depends on individual circumstances and applicable tax law. Consult appropriate financial, insurance, tax and legal professionals regarding your individual circumstances.
Securities and advisory services offered through LPL Financial, a Registered Investment Advisor, Member FINRA/SIPC.