How to Choose Life Insurance
• Benefits provide living income for surviving family members. This is also known as "family risk insurance" and it's a personal policy that replaces the cash flow of the business in the event of death. "If the owner is dead, there is a good chance the business won't survive," Patrick says. If you're an employee, this type of policy can help provide for your family in the event of your death. In this case, the owner should be a trust outside of the business or a spouse or surviving family member.
• Supplemental retirement savings. This type of insurance would provide cash value of the policy to help fund retirement or a buy-out of the insured, in the event that they live long enough. These policies are typically not used to cover the owner of a company but for other key people and it can sometimes be used to attract executives or key staff. In this case, the owner would be a trust outside the business.
• Estate tax funding. This is also known as "wealth transfer insurance" and it's a privately-owned policy set up to protect heirs in the event a business owner dies and the surviving family members must pay estate taxes if the business has been successful and is worth a lot of money, Patrick says. In this case, the owner would be a life insurance trust.
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How to Choose Life Insurance: Understand the Types of Insurance Available
Understanding how you intend to use the life insurance policy or policies will help you decide which type of insurance to choose. Life insurance is broken into two broad categories: term insurance and permanent insurance. But there are also several sub categories.
Term Insurance
Term insurance is typically purchased for a particular time frame -- 5, 10, 15, 20 or 30 years -- and pays a benefit only if you die in the insured term, Patrick says. "If you don't die during the insured term, there is no return on the policy," he adds.
Permanent Insurance
Permanent insurance is designed to be used in both life and death, Patrick points out. "Permanent insurance has two components: death benefits and cash value," he says. "A death benefit is the money that is paid when you die -- for survivors' living expenses, funds to keep the business going, or providing liquidity to pay estate taxes that may be due. Cash value is the amount of money the policy is worth during your lifetime if you decide to either end the policy or borrow money from the policy." That cash value can provide supplemental savings for activities such as purchasing a house or retirement income.
Permanent insurance has several sub categories:
• Whole Life Insurance. This contract pays a dividend from the issuing company and cash values grow as dividends are declared by the issuing company, Patrick says. Dividends come from profits of the company as well as investment returns on invested premium dollars the company earns.
• Un iversal Life Insurance. This contract allows flexible premium payments and has a term insurance component as well as a cash account component, Patrick says. The term insurance costs are deducted monthly to provide the life insurance and the excess cash in the policy is credited with interest from the insurance company. The excess cash typically earns an interest rate that is very close to what can be earned in a bond account.
• Variable Universal Life. This contract is the same as universal life with the exception that there are several sub accounts the owner of the insurance policy can choose, Patrick says. Typically the sub accounts will have stock as well as bond accounts within the policy. The owner of the policy will choose the asset allocation and take the risks of whether the market increases or decreases the cash in the policy. This policy is typically used for those who are looking for supplemental retirement income.
In deciding what type of life insurance to purchase, cost may be a factor. "Term insurance is what most businesses do when they are starting up because it is inexpensive and often everyone is watching every penny," Tassey says. "But as a company grows and becomes more successful, they may want to consider permanent insurance, which accumulates money over time." That money can be used to help the company go through a bad stretch, or if access to bank credit gets tight, because depending on the policy they may be able to take a loan or a withdrawal, Tassey says. A company-owned permanent policy is a corporate asset that can be used to subsidize a retirement payout or even the purchase of company assets.
