Life insurance coverage should be considered as an integral part of any good solid financial plan – both personal and business.
The proceeds from such policies can be used to provide numerous benefits, including the payment of final expenses, paying off a mortgage or other debt, funding a child’s future college education costs, or providing ongoing income to a surviving spouse and family.
The funds from a life insurance policy can also be used to continue paying the overhead expenses on a medical practice upon the unexpected loss of a key physician while a replacement is being sought or the business is being sold.
Physicians Life Insurance: Coverage Types
Although there are many variations of life insurance, there are two primary types of coverage that are available in the marketplace – and the type of policy you end up picking can have a real effect on the premium that you pay and the benefits that your loved ones may ultimately receive.
The key forms of life insurance are term and permanent. Term life insurance is typically considered to be a “temporary” type of coverage. With a term life insurance plan, the policyholder’s monthly payment is the same throughout a set time period – or “term” – such as 20 or 30 years, in return for a stated amount of death benefit protection should they pass away during the time that the policy is in force.
Because term insurance policies provide only life insurance protection without any type of cash value or investment fund build-up, the premiums on these plans are typically quite low. This is especially the case if the insured is young and in good health when he or she initially applies for coverage.
Physicians Can Invest AND Protect for Less
The initial low premium aspect and set time frame also make term life insurance a good fit for most physicians’ life insurance coverage needs. Why? There are several reasons, but here are the top three.
Higher Amount of Coverage
Because the premiums for term life insurance are typically so inexpensive, policyholders are able to purchase higher amounts of coverage – and this can be a real benefit for physicians. In many cases, and especially for those just starting residency, the likelihood of your income rising are quite good. This typically means that your income replacement needs going forward are also likely to increase. With this in mind, your income replacement and protection are going to increase.
Although there is no cash value or investment component associated with term life insurance, the death benefit proceeds from these plans can be used just like any other types of life insurance. Therefore, funds can be allocated for income replacement, debt payoff, and other business or personal expenses.
Leaves More Discretionary Funds to Invest
Term life insurance is known for being inexpensive coverage. Having this coverage will allow you to protect what’s important to you such as income replacement for your spouse and children, payment of debt, and reduction of other financial obligations, while at the same time allocating a high percentage of your other discretionary income towards saving and investments.
In doing so, you can accomplish several things. First, you will be able to more quickly build up your savings and retirement fund. By purchasing a term life policy over a comparable amount of permanent life insurance coverage, you will be savings a great deal in premium.
The key here is to be disciplined in allocating a certain amount of funds on a regular basis towards building savings and investments. As these funds build, it could even become possible to self-insure in the future.
Even though permanent life insurance can build up considerable cash value over time, life insurance should never be purchased solely for savings or investment, as a large percentage of the premium on most any policy will be going towards paying for death benefit coverage and other policy expenses.
Temporary Premium Payments for a Temporary Need
As you continue to build wealth in the form of savings and investments, it is likely that at some point, you will no longer need the protection of the life insurance proceeds, as you will eventually be able to self-insure your debt and income replacement needs. Until that time, term life insurance allows a way to very inexpensively provide the protection that you need.
One Slight Exception to the Term Insurance Rule
While covering your temporary life insurance needs with term insurance makes a great deal of sense, there is one area where you should consider holding a permanent life insurance policy. This comes into play with estate planning.
Many of those who are considered to be high net worth individuals spend a great deal of time and effort in an attempt to minimize estate taxes – which for some, could turn out to be more than half of their total estate’s value. Yet, while estate taxes can never be completely eliminated, they can be effectively reduced by using various methods of structuring life insurance policy proceeds.
For example, by using an Irrevocable Life Insurance Trust (ILIT), it is possible to transfer life insurance proceeds to your beneficiaries while at the same time reducing or even avoiding estate taxes altogether.
The basic exclusion amount for anyone who passes away in 2013 is $5.25 million. That means that any amount above that could potentially be taxed as high as 40%. It’s also important to note that even though someone who dies with a net worth under $5.25 million may not be liable for paying federal estate tax, they may still be subject to state estate taxes.
As a hypothetical example, let’s say you live in a state with a 16% state estate tax and a state exclusion of $1 million per person. You and your spouse have a combined net estate of $3 million. Of that amount, $1 million is in life insurance proceeds.
Upon your death, $1 million of your assets would be protected due to the state exclusion. However, because you own the $1 million life insurance policy directly, this amount would be included in your taxable estate, and would be taxed at 16% – thus costing your estate $160,000 in estate taxes. If, however, this policy was owned inside of an ILIT, incidence of ownership would be removed from your estate, saving your estate $160,000 in estate tax liability.
Using an ILIT to own the insurance can offer several other significant advantages as well, such as:
- The ILIT can be used to provide for your surviving spouse, with the remaining balance, if any, at his or her death passing to your children;
- The ILIT can be structured to continue as a vehicle for managing and preserving wealth for your children and/or grandchildren;
- The ILIT can even provide a source of cash to the executor of your estate for the payment of estate taxes (if applicable).
A well constructed estate plan can serve as both a personal and financial safeguard for your family and other beneficiaries – and, without a good solid plan in place, your loved ones could essentially end up paying excessive estate, income, and capital gains taxes, even if your portfolio has lost value in the market.
A permanent life insurance policy can play a big part in the creation of an estate plan. It can offer a variety of benefits to the estate, including the accumulation of wealth, estate liquidity, and the ability to pay off debts. It will also stay with you throughout the remainder of your life – provided that the premiums are paid as, unlike term insurance, permanent life insurance provides protection for life.
Properly drafting an estate plan will, however, require removing the life insurance policy proceeds from inclusion in the estate. Otherwise, these funds will become taxable – adding to your overall estate tax liability.
Therefore, it’s probably a good idea to seek advice with an attorney who is familiar with estate planning, as well as a life insurance specialist, in setting up your estate plan in order to ensure that the plan will work best for you and your specific situation.
The Bottom Line on the Right Type of Life Insurance for Physicians
While the phrase “buy term and invest the difference” may at times be overused, it does hold a great deal of validity – and, if properly implemented, this strategy can allow you to accumulate a great deal of wealth while at the same time protecting assets for practically pennies on the dollar. This technique can also provide you with the opportunity to eventually drop your term life insurance when the time is right, eliminating the premium payment altogether.
When purchasing life insurance, it is essential to know the difference between the plans that are available and how they work, as purchasing the wrong type of coverage has the potential to affect your entire financial plan.
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