Things to be Aware of Regarding Life Insurance Policies
Important Policy Provisions
- Most permanent life insurance policies provide that the insurance company will give you a loan of a portion of the cash value. The insurance company will charge interest on the loan as specified in your policy. If you borrow from the insurance company and the amount exceeds the cash value over time due to interest, your life insurance policy will terminate within a specified number of days unless a payment is made. Any remaining portion of the loan unpaid at death will be deducted from the death benefit.
- Life insurance benefits can be paid in various ways called settlement options. Some of the options generally available include: a cash or lump sum payment; interest only option where the insurance company keeps the benefits and provides payment of the interest; fixed period option where benefits are paid out over a predetermined number of months or years; fixed amount option where the death benefit or cash value is paid out in a specified amount each period; life income option where the benefits are paid for the life of the beneficiary. Combinations of these options are also available.
- Cash values provided upon termination of your policy can be generally paid out in cash; as reduced paid up insurance where the cash value is used to purchase a permanent life insurance policy that is paid up (i.e., no premium payments are required); or as extended term insurance where the cash value is used to purchase a term insurance policy.
- A grace period is defined as the additional number of days beyond the due date of the policy when you can pay the premium without interest or fear that the policy will terminate (lapse). If your policy has enough cash value and you have elected on the application to have an Automatic Premium Loan, then any available cash value will automatically pay for the premium. An automatic premium loan can prevent the policy from lapsing.
- In the event you die during the grace period, the death benefit will be reduced by the amount of premium due.
- All life insurance policies contain an incontestability clause. This clause will not allow an insurance company to deny a death benefit or terminate a life insurance contract after a specified period of time, usually two years. This clause has the effect of requiring the company to thoroughly investigate the information provided in an application during the first two years.
- Most insurance policies contain a suicide clause. This clause allows the insurance company to refuse payment of a death claim if the insured commits suicide within the first two years of the policy. The insurance company must return premiums paid on the policy.
- In most cases, cash value and policy loan requests are granted quickly. However, all life insurance policies contain a delay clause that allows the insurance company the right to wait up to six months before providing a cash value or policy loan.
Multiple Life Policies Vs. Single Life Policies
- Multiple life policies insure the lives of more than one person on a single policy. There are two types of multiple life policies. A joint life policy pays a death benefit when the first person dies. Since joint life policies are less expensive than purchasing two individual policies, they are commonly purchased by a husband and wife who are each other’s beneficiary. A second-or-later-to-die policy pays a death benefit when the last person insured under the policy dies. Second-or-later-to-die policies are often purchased by married couples who want to protect their assets from federal estate taxes.
- Single life policies insure the life of only one person and pay a death benefit when that person dies.
Group vs. Individual Policies
Life insurance is sold on both an individual and group basis.
- Individual policies provide coverage to a specific individual under a policy issued solely to that individual. In order to be considered for individual insurance coverage, you will be asked several medical questions and may be required to undergo a medical examination. The insurer will use the results to determine whether to sell you the policy. This is called medical underwriting.
- Group policies provide coverage to individuals under a single master policy issued to the group policy owner. The policy owner may be an employer, an association, a labor union, or other entity. Unless the group is small, generally ten employees or members or fewer, no individual medical underwriting is performed. Instead, insurers require employee or member minimum participation levels and minimum employer contribution levels in order to assure that there are sufficient individuals in the group in good health to balance those in the group in poor health. One drawback to group life insurance is that it will often terminate when you leave the group unless there is a conversion option to an individual policy.
Your insurance producer may suggest that you replace an existing life insurance policy with a new one. The suggestion to replace a policy may be made because your life insurance needs have changed, a new policy has some additional features that would be useful for you, or for another reason. Before you agree to replace a policy, you should understand the advantages and disadvantages of replacing your current policy.
Replacing a current policy may mean giving up certain valuable benefits and rights that may not be available on a new policy or may not be available for a number of years. Review your life insurance policy incontestability period. Before purchasing, compare your current policy with the new policy and consider the guaranteed benefits, cash values, and your rights under both policies.
A rider is a written agreement that attaches to a policy to add, subtract, or modify insurance coverage. A rider takes precedence over the original provisions in the policy.
- An accelerated death benefit rider is often available at no extra charge, and will allow you to take all or a portion of the death benefit early if you become terminally ill or have a specific disease. Some of these riders also provide you with a monthly payment if you require long-term care due to a medical condition as defined in your policy. The death benefit and cash value of your policy will be reduced by the amount you have received plus incurred interest on the paid out amount. It is important to consider that the amount of death benefit taken early will likely be considered income. This means that the benefit will be subject to federal taxes and will also be included in any income calculation for purposes of determining eligibility for government programs such as Medicaid.
- A waiver of premium rider will pay your life insurance premiums if you become totally and permanently disabled according to the disability definition in your policy. The insurance policy continues just as if you were paying the premiums. This rider can generally be purchased for a small extra premium.
- An accidental death benefit rider doubles or even triples the death benefit if you die from an accident. This rider can be purchased for a small extra premium. The division recommends that before purchasing this rider you carefully consider that the amount of coverage you need does not depend on cause of death.
- A guaranteed insurability option allows you to purchase additional amounts of death benefit at stated periods of time without providing evidence of insurability. This rider may be of value to those with a family history of significant medical problems who currently have limited income and cannot afford a larger death benefit.
- A family rider allows you to provide term insurance on all or certain members of your family under your policy.
The division recommends that you consult with your tax advisor regarding the taxability of life insurance benefits. However, the following are some tax rules that generally apply to life insurance policies that meet the federal definition of life insurance:
- Death benefits are not subject to federal income taxes.
- Dividends are considered a return of excess premium and are therefore not taxable. If dividends are left with the insurance company to accumulate interest, the interest is taxable.
- Interest credited on life insurance cash values is not included in current taxable income.
- Cash value payments that exceed the sum of premiums paid, less any dividends paid, are subject to federal income taxes.