When financial advisors discuss life insurance with their clients, the focus is usually on the death benefit as it should be. However, many times clients have little or no understanding of the features and benefits that certain types of life insurance contracts provide in helping to grow their estate and preserve their legacy. During their life, clients might need quick access to capital for an opportunity or emergency. What if the client becomes sick and needs nursing home or home based healthcare? Some types of permanent life insurance, like whole life, provide powerful benefits for the insured while he or she is living. The strong guarantees offered by whole life contracts can be very appealing to clients who are quite risk averse. Guaranteed cash value growth and a guaranteed death benefit are evidence of the great degree to which risk is shifted from the whole life policy owner to the whole life carrier. As such, this article focuses on the living benefits of using whole life insurance as a legacy and estate planning tool. In evaluating the living benefits of whole life insurance, we will discuss the estate building potential of cash value in a whole life contract, provisions related to skilled nursing care, and how the guaranteed benefits could enhance distributions from the insured’s retirement assets as well as his or her overall legacy.
Access to Capital throughout Life
Access to capital can be an important part of building an estate. If an individual does not have access to capital when an investment or business opportunity arises, those opportunities could be lost. Also, there are different strategies for utilizing capital. Many clients do not realize that, all things being equal, paying interest on a loan costs the same as not earning interest on cash withdrawn from a savings account. For example, suppose client A and client B each need $10,000 to purchase new equipment for their small business. Client A withdraws the $10,000 from a savings account earning five percent interest. Client B takes a loan from a financial institution at five percent. Both client A and client B pay back the loan over five years. The cost for client A and client B is the same after five years. This is true because client A has lost five percent compounding interest over five years, and client B has paid five percent amortizing interest over five years. A third option is for client A to use the $10,000 in the savings account as collateral. This would allow the client’s savings to continue to compound at five percent uninterrupted during the loan repayment period, taking advantage of the power of compounding.
Accumulating and collateralizing cash inside a life insurance contract has many advantages. Whole life insurance guarantees not only that a certain interest rate will be earned on the cash value in the policy, but that the cash value will continue to grow. Other types of policies might offer a return of premium after a certain number of years, but these ROP provisions cannot be used as collateral and typically require a complete surrender of the policy jeopardizing the insured’s legacy. One of the biggest advantages to cash value relates to tax treatment. Cash value grows income tax deferred inside of a properly structured life insurance contract. Also, the cash value can be accessed income tax free when distributions or loans are done properly. Utilizing the cash value inside a whole life insurance contract as a source of capital can be a powerful strategy in helping to build an estate, but whole life insurance can also help to protect an estate from unexpected health issues.
Healthcare Riders
One of the biggest risks to a client’s estate is the need for nursing home or in-home care for an extended period of time. Studies show 72 percent of Americans become impoverished after just one year of nursing home care.1 The average cost of a six-hour visit by a home health aide is $114 per day or $29,640 per year.2 The cost to stay in a nursing home averages about $80,000 per year for a semi-private room.3 Long term care, chronic and terminal illness riders are a relatively new feature of whole life contracts and can be an option to help protect an insured who is unwilling to pay for, or does not qualify for, long term care insurance. For example, client A knows that an individual is more likely to become disabled than die prior to age 65, but she is concerned that she will pay premiums for 10 years or more and receive no benefits from the LTCI policy.4
Some whole life contracts have long term care or chronic illness benefits linked to the base policy. Some of these riders require additional premium and provide a guaranteed amount of long term care benefit. Other healthcare riders, such as those called chronic illness riders, require no additional premium and provide an acceleration of the death benefit to help cover the cost of in-home or nursing home care. Typically, chronic illness riders require little or no underwriting, and are easier to qualify for than long term care riders. Details of these benefits are beyond the scope of this article and might not provide a complete solution for nursing home care. However, linked benefits can provide a measure of protection for those clients who do not qualify or are unwilling to pay LTCI premiums. Another source of funds for skilled nursing care might come from the client’s other retirement assets. Whole life insurance can provide clients with the freedom to maximize the distribution from other retirement accounts while still maintaining their legacy.
Term policies do a great job of protecting family members from the financial impact of losing an income-producing spouse. However, only about one percent of term policies ever pay out a death benefit.5 The guaranteed death benefit of a whole life contract ensures that clients will be able to leave a legacy to their children, grandchildren and other heirs. However, a whole life policy might also benefit the quality of the insured’s retirement. If the death benefit is large enough, the whole life policy allows the insured to spend down the retirement assets he has accumulated over his working years without fear of depriving loved ones of a legacy. Alternatively, whole life could be used strategically to increase the annual income of retirees while helping to preserve or even increase the legacy to their heirs.
Advantage of Combining Products
According to the research of Dr. Wade Pfau, PhD, CPA, a higher income level and greater legacy are potentially achieved when investments, single life annuities and whole life insurance are combined than when applying investment-only solutions. Whole life insurance and annuity products, “which invest primarily in a fixed income portfolio, can better hedge a retiree’s personal income needs. By combining them, the overall planning horizon can essentially be fixed at something close to life expectancy, as whole life insurance provides a higher implied return when the realized lifetime is short, and income annuities provide a higher return when the realized lifetime is long.” Dr. Pfau’s research indicates the use of whole life insurance and single life annuities are a more effective way to use fixed income assets as a tool to reduce volatility in a portfolio.6
The primary purpose of whole life insurance is to provide a guaranteed death benefit to the insured’s chosen heirs. However, the power of whole life has the potential to enhance the size of the insured’s estate by providing efficient access to capital when opportunities arise. Whole life insurance could also protect the insured from the financial impact of the need for nursing care with healthcare related riders. Finally, whole life contracts, when used as an asset class, could improve the retirement income and legacy of the insured over the use of an investments-only retirement strategy. For these reasons and more, whole life can be a powerful solution for living and legacy.
Footnotes:
1. Harvard University Study in Compensation & Benefits Review
2. John Hancock Life & Health Insurance Company. “John Hancock 2013 Cost of Care Survey,” conducted by LifePlans, Inc., April 2013.
3. Genworth Insurance Company. “2015 Cost of Care Survey, Home Care Providers, Adult Day Health Care Facilities, Assisted Living Facilities and Nursing Homes,” 2015.
4. American Society of Actuaries.
5. Money-zine.com, “Term Life Insurance Policies.”
6. Dr. Wade Pfau, PhD, CPA. 2015 “Optimizing Retirement Income by Combining Actuarial Science and Investments.”
