The Wonderful World Of Life Insurance

And welcome to another episode of Mr. Stillman's Opus. Walter Storholt, your host today, alongside Jon Stillman, the man we turn to for guidance and advice in the financial world. And Jon, I see that the headline of our topic today is life insurance. Why in the world would we bore ourselves and listeners with such a topic? You realize that our goal on the podcast is actually to get people to listen to all of it, not to tune out immediately.

Thank you for that wonderful setup. Well, I know that the good news is that you do tend to take topics that I think the outside world would view as somewhat boring and make it interesting or at least applicable to our everyday lives. But maybe that's where we start when we talk about life insurance. Why is there that cringe-worthy, almost nails on a chalkboard type feeling whenever somebody brings up life insurance? I mean, Groundhog Day, perfect example of how they pick on Ned, the life insurance guy. Ned Ryerson.

Yeah. Well, he's sort of your stereotypical life insurance salesman, right? And when that's all you do is sell life insurance, you're going to be pushing it on people whether it makes sense for them or not. So I think there have been a lot of people in the history of America who have only sold life insurance and therefore they have become Ned Ryerson in real life. So that stereotype, as with most stereotypes, exists for a reason.

There's some truth in each of those stereotypes. But the other thing is people just don't like to talk about it because it has to do with dying, right? I mean, you're either buying life insurance on yourself to take care of your family if something happens to you or you're buying life insurance on somebody so that you'll be taken care of if something happens to them. Neither is a particularly pleasant discussion, with maybe one exception, who is a client of mine who went through a very nasty divorce. And as part of the divorce decree, she still gets half of her husband's pension, which is a substantial pension. But as part of the divorce decree, he has to maintain a life insurance policy on himself because if he died, she wouldn't have that pension anymore. So he has to have life insurance on himself for her. So she loves talking about his life insurance because, you know...

It's a win-win for her. Yeah, pretty much. But all joking aside, that's about the only time I can think of where anybody's really wanted to have an exciting talk about life insurance. The emotional attachment to life insurance is usually of a much more, I don't want to say negative, but it leads to avoidance.

People don't want to talk about it. Right. And so a lot of people think of life insurance as something that they need to take care of their family while they're in their earning years in case something happens to them. So the classic example is have a young couple and they're both making $60,000 a year.

They each have, let's call it 10 times their income, maybe five times their income, whatever. That's their death benefit on a term life insurance policy so that if something happens to them, their kids are taken care of, right? Then you say, all right, well, the kids are grown and gone, out of the house, college is paid for, do we still need life insurance at that point?

Well, maybe, maybe not. It could be that the reason to have life insurance is completely different. Like, let's say, for instance, that couple that I just referenced that was divorced, well, let's say they were still married, but he didn't have a spousal benefit on his pension. Let's say he's getting $6,000 a month and he dies and that's gone. Well, that's a big income gap for the widow to make up.

Sure enough, yeah. So, we'd want to have some life insurance on him. For other people, it's an estate planning issue. So, life insurance proceeds, of course, pass tax-free to the beneficiary, right? So, very wealthy people who are actually concerned about the tax implications of their estate will often buy as much life insurance as companies will sell them, because that's how they can transfer wealth to the next generation tax-free. So, it's not as simple as the use of life insurance that most people think of it as. In other cases, there are situations where maybe people want to add liquidity to their estate.

So, let's suppose, here's an example from a client. They inherited a farm. It was about 45 acres. Not a big income-producing farm, just a lot of land. So, it had a lot of value, but not a lot of cash flow.

Not really any cash flow, to be honest. So, the problem was, the market value of that farm was probably close to a million dollars. But the problem was, the tax bill was huge. And so, there was nothing else in the estate. She just inherited land, and that was it. So, it's not like it was producing any sort of regular income for them, or it was producing any crops, or had any sort of workability in it?

There were people working it, but it wasn't really making a profit to the person who owned the land, really. And it got to the point where, after a year or two, she was having trouble just paying the taxes on the land. So, instead of having a million-dollar property, she decided, look, I need to sell it, and I need to get it sold quickly. So, she ended up selling it for $550,000 or $600,000, because she had to get it moved. So, she didn't really get the value out of it that she could have. If her dad had had even a small amount of life insurance to add some liquidity to the estate, she could have paid the taxes on it long enough to get the price that she wanted for it. Interesting. So, it could have been used in that situation, really, just as a buffer, to give you some extra time, so you're not rushed into a decision. That seems like a very creative use of life insurance.

Yeah. So, if you have a very illiquid estate, a lot of properties, it might make sense to have some life insurance in there. You don't have to have a huge amount, but just enough to make it easier to administer the estate, for one. And for some people, maybe you have a lot of assets, but they're all in IRAs. And if you're passing $1 million in IRAs to your kids, well, you also want them to have some tax-free assets to deal with, too. So, there are a lot of legacy planning issues, where it might make sense for you to have life insurance, even if you don't need it to take care of somebody.

It's a little better. We still are all dealing with people dying in order to realize the benefits. Is there any particular use of life insurance that would benefit someone that doesn't deal with death while they're still living? In rare situations, yes. So, as an example, for people who have really high incomes, you can actually use life insurance as a way of investing for future income. Now, I'm not real crazy about that in most cases.

I've only really seen a few cases where it actually makes sense. But if you have somebody who has a really high income, they can't contribute to a Roth, they can't even contribute to an IRA and get the deduction, they're very limited. They can max out their 401K. But let's say you're making $500,000 a year, and you can max out your 401K at $24,000 if you're over the age of 50. But other than that, all of your savings are in after-tax accounts. It would be nice to have some place where you could save tax-free down the road while we've already determined you make too much to contribute to a Roth. The other two options are municipal bonds, almost as boring to talk about as life insurance, and the life insurance. So, what you can do is essentially overfund the life insurance policy, and then you borrow back from the cash value of that policy to give yourself income down the road. But there are actually some policies that have some pretty good growth potential within the cash value if you do it right.

It's a little bit of a complex way of doing things. It really doesn't make sense for the overwhelming majority of people, but for some really high-income clients, it has been a logical way to go. We found the exception to being able to use it while you're still living. Now, there is also the living benefit idea of life insurance.

Now, this is also not a fun thing to talk about, because now we're talking about nursing home or assisted living. But the way that works is, let's say that you have a $250,000 life insurance policy on you. When you die, Connie gets $250,000, very simply.

We won't tell her that, because we don't want you worth more dead than alive, but that's how it works sometimes. However, let's say you were to go into the nursing home. Well, you can use that $250,000 to help pay for your care. Not in a lump sum, but they might give you a quarter of it every year for four years.

But that seems useful. So yeah, if you get $60,000 from that policy for four years, yes, there's not any death benefit left to pass on, but you've at least prevented the remaining spouse from having to spend down all the accounts to pay for your nursing home care. So, again, not a real pleasant conversation, but that is a good use of life insurance. Some people have a ton of old life insurance policies that they just need to scrap, just need to not have. I had a lady in here a few weeks ago, who has three or four old life insurance policies, none of which she really needs. She needs a little bit of life insurance to help with the estate plan, but she didn't need the $600,000 of coverage that she had. So we basically scrapped all that, got a new policy for about $100,000, which was all we determined that she needed. Now she's paying much less in premiums every year, but she still has the coverage that she needs. So in a lot of cases, people are still paying on old policies that they've had for years that there's no need for them to keep.

Gotcha. So starting the life insurance conversation actually could save people money if you uncover situations like that, or ways to be more efficient in your coverage. Right, and really the way to save money, this is the thing people don't understand, is that life insurance is the one thing, other than big screen TVs, that have gotten cheaper over the years. The reason for that is, people are living longer, right? So as life expectancies increase, life insurance companies can collect premiums longer period, therefore it costs you less to buy life insurance. So whereas it may have once cost you $100 a month to have a certain amount of coverage, you might be able to get that same amount of coverage today for $70 a month. So that's something that people don't understand about the old policies they have. They think, well, I got this back in the late 90s, it's probably a really good deal compared to what I have now.

Actually, probably not. You could probably get the same thing much more cheaply. So the other advantage there is, let's say you have an old whole life policy, and you're paying, let's call it $100 a month, and you have a cash value of $50,000 in that account. Pick a nice death benefit.

Let's call it half a million dollars. So quick review, half a million dollar death benefit, we're paying $100 a month and we have a $50,000 cash value that's built up. Well, it's completely possible that with today's rates being what they are, you could take that $50,000 cash value, move it to a new policy, and never pay premiums again. So you just cut out the $100 a month and essentially take that $50,000 as a prepayment on the new policy and you're done. No more premiums to be paid, or at the very least, pay a lot less than the $100 a month that you have been paying and keep the same coverage. So that's an example of when it might make sense to scrap an old policy. Now, certainly you don't want to dump an old policy and then wait for the underwriting process to go through on your new policy, because what happens if it comes back and they find out that you're in bad health and you either are uninsurable or it actually does cost more than you were expecting? Well, now we have a problem. So you keep the old policy in place, you get the new one, and then drop the old one.

That makes sense. So I know that there's always sort of a debate for folks who are in that younger stage of life. Do you get term?

Do you get whole, universal? What about folks who are approaching those retirement years, maybe five, 10 years away, or just started retirement? Is the debate the same? Does it change when you're talking term, whole, universal? It is a different type of policy for a different stage of life. So for you now, for me now, for almost anybody in the younger stage of life, term is going to be the way to go. However, as we're getting toward the end of life, very often, especially if we're using it for an estate planning purpose, yes, we want some kind of permanent policy, usually universal life policy. If we want to have the living benefits like we were talking about for nursing home use, that's going to be a universal life policy in almost all cases. So yes, you just want to be sure that you're using the right policy for the right stage of life. Term life insurance would be more for income replacement for a certain stage.

We have to get through this age or get the kids through college or whatever. Throughout that term, we want to have coverage. That's your use of a term policy. If we're using it more as a financial planning instrument other than just an income replacement tool, then we're looking at different types of policy. Just make sure you've got your beneficiaries correct, right?

Oh, well, look at you. The last point we should probably make, at least. Yeah, so be sure your beneficiary designations are up to date. The classic example, of course, is a married couple gets divorced. Husband remarries and dies. He never thought to update his beneficiary designation. Ex-wife, who he wasn't on good terms with, is still the beneficiary in his life insurance policy.

That goes to her. His actual wife, who he would have wanted to get it, gets nothing. Regardless of what it says in his will, the life insurance beneficiary dictates who gets the money. And you cover that kind of stuff in a review with someone, right? Yeah, we check every year when we're going over your annual review. All right, let's review your beneficiary designations on everything.

Not just life insurance, but IRAs, any accounts that have a beneficiary. Let's be sure those are still who we want those to be. Good conversation. And we made it through the whole conversation without falling asleep. C wasn't so bad. Congratulations. Not bad at all. There you go. That's the skinny on life insurance, if you will. And this has been Mr. Stillman's Opus.