As with your investment portfolio, life insurance can be vitally important to your long-term financial picture. Unfortunately, many policyholders adopt a set-it-and-forget-it approach with one of the most essential elements of their estate plan—they file their policy in a safe place and expect it will deliver when their families need it most.
However, assuming your life insurance will run on autopilot can be dangerous to your wealth. Disappointing stock market returns have left many variable policies—whose face value is tied to an underlying equity product—under-funded. Meanwhile, overall market conditions have also impacted whole and universal life policies due to the manner in which insurance companies declare credited interest rates.
As a result, many policyholders today face the unappealing choice of higher premiums or investing more money in their current policies simply to keep pace with where they thought they would be when they first purchased the coverage. To help avoid this situation, it is wise to understand how economic factors impact a policy and which strategies can help ensure the greatest future benefit for heirs.
How Market Performance Impacts Policies
In any estate plan, life insurance has the unique advantage of being the last potential refuge from tax exposure. As long as an individual other than the insured owns the policy, the proceeds can pass onto beneficiaries completely tax free, which is why insurance plays such a fundamental role in both tax planning and wealth generation strategies for heirs.
Insurance can be particularly effective when used in conjunction with an irrevocable life insurance trust (ILIT). For instance, you can set up a trust for your children, have the trust purchase the policy, and pay the premiums with your annual tax-free gift exemptions—currently $14,000 per person, per beneficiary, this year. When you die, your heirs will be able to collect the proceeds from the insurance trust tax-free.
While this can be an effective strategy, it will be ineffective if your insurance policy is not performing as you expected. Variable policies, whose value is tied to the funds in an underlying portfolio, have been hit with a one-two punch from the markets. First, the value of an equity portfolio has been impacted by market performance; second, some insurance companies have opted to raise their fees because their own portfolios are underperforming expectations. The result is that the optimum scenarios illustrated with aggressive 11% and 12% annualized return projections could now fall well short of that mark if you purchased the policy only several years ago.
Even universal life policies, which offer fixed rates of return, are not quite as fixed as many policyholders may have assumed. With most universal policies, the rates of return are tied directly to the insurance company's separate portfolio returns, which have been buffeted by rising interest rates that are driving down the value of their bond portfolios. Thus, policyholders may be facing a much smaller benefit than they anticipated when they first signed up.
Evaluating Your Policy and Provider
To find out exactly what your insurance is worth today, it is advisable to sit down with your advisor and run a "fire drill." If you were to die today, what would your heirs receive? If your policy falls short of expectations, there are several options for getting back on track and ensuring your estate or wealth creation plan is fully funded.
The first choice is to add the additional premium funding or lump-sum payment necessary for meeting income projections. Before you automatically increase your contribution, though, consider that now is the perfect time to step back and make sure this is still the right policy with the right insurance company. Your needs are likely to have changed, so make sure you do a thorough, bottom-up review before putting additional funds into your existing plan.
A good starting point is a thorough analysis of your existing insurance company. There are more than 2,000 insurance companies offering policies, but only about 300 make it into top-tier ratings. Several independent, third-party research firms—such as A.M. Best, Standard & Poor's, and Moodys—can provide an objective analysis—so make sure your insurance company is still a solid choice by checking its current ratings and then comparing them to past performance. Have they slipped?
If so, you may want to evaluate if the change is significant enough to merit changing insurance carriers. You should also evaluate what types of coverage options your current policy includes to be certain you are not incurring fees for features you may not really need.
A consistent, ongoing review is the only way to ensure that your insurance planning and overall planning are on track. Because your beneficiaries' future security depends on how thorough your coverage is, you cannot afford to file it away and forget about it. It is advisable to revisit the policy every 18 months and ask your advisor to help you ensure it can still provide an important support to your overall wealth transfer and estate planning.
This article is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service or as a determination that any investment strategy is suitable for a specific investor. Investors should seek financial advice regarding the suitability of any investment strategy based on their objectives, financial situations, and particular needs. This article is not designed or intended to provide financial, tax, legal, accounting, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought.