Before buying life insurance, physicians need to consider a plethora of factors. Here are the most important of the bunch.
The fourth quarter of the year is when life insurance sales kick into high gear. In many cases, life insurance is often sold as tax savings plans. Here are the questions you must ask before purchasing this important asset.
The majority of this discussion involves the use of some form of "whole life" insurance that has a "cash value," as opposed to term life insurance which does not build a cash value. The first rule is always to get any promise about your policy and any important numbers, guarantees, cash values and the premium commitment you are making in writing. A policy illustration created by the insurance company itself will have your name, the date, and other details and is separate from any general marketing or illustrations that you may be presented with as sales materials. The policy illustration represents your actual numbers, and when you combine the illustration with the issued policy document itself you have the full legal description of what you bought.
•Is this going to be taxable to my beneficiaries?
Insurance proceeds left to a spouse are tax free, but that may or may not be true for your other heirs. Factors to consider include who they are and if you have an estate tax exposure. In some cases an irrevocable life insurance trust (ILIT) may be required.
•Are my cash value and/or death benefit creditor protected?
Laws vary from state to state, but the majority of states protect life insurance by law to some degree. How much is protected, for whom, and if that protection includes bankruptcy are just a few of the variables to consider. This is especially true at this time of year, when the plans you are being pitched will often include a retirement savings component that you are told you will borrow back from to create income. If you will have hundreds of thousands of dollars in cash value that is not protected by law in such a plan, an ILIT may be a good option to consider.
These are the basic liquidity and exit plan questions. Ask when you will have a cash value, how many payments you have to make to keep the policy from lapsing before you could cash in the policy and walk away whole.
•When do I have full cash value?
In some cases a policy will require you pay for several years before the policy is actually worth what you have paid in large annual premium payments. In other cases there are significant surrender penalties for the first several years if you cash in early.
•What are my premium payments and can they change?
Understand the total financial commitment you are making and be sure that you can live with the very large annual premium that some plans require to build a critical early mass of investment cash in the policy. During the recession I saw many doctors become cash poor and put in a position where they had to let polices lapse, losing all their payments. In other cases policies that assumed a certain rate of return but that didn't have floors or guarantees required more premium payments or bigger payments and other doctors had to cash out early, paying huge penalties to try and salvage something or for emergency access to cash.
•Can I leverage it?
In some cases life insurance polices can be very flexible assets, and can be collateralized for a loan, credit, bonding and etc. In other cases you can borrow a very large portion of your cash value out of the policy at a low rate of interest while keeping the death benefit in place. Investigate both these options, the interest rate and how much you can actually make liquid this way. We have seen this be a deciding factor in a variety of business contexts.
•How long will this policy last and can the death benefit change?
You must know how many years the death benefit will be in place and if that benefit is fixed for the entire term or if it will decline as years pass. In some cases, you can lower the death benefit after a significant period of years to keep the policy in place longer or make additional contributions, so ask questions about these options as well.