Although it’s often an uncomfortable topic to discuss, life insurance remains a great way to provide for your family and loved ones in the event of your death. But there are a number of different kinds of life insurance as well as relevant laws that may apply to your policy at some point. The article below provides an overview of common life insurance policies and laws.

Types of Life Insurance

As you start to plan for the future, it’s good to have an idea of the different life insurance policy options you can choose from. One decision entails whether you want an individual policy or a “second to die” policy (also known as survivorship life insurance). An individual policy insures just you, while a survivorship policy insures two people, like spouses. When the first person dies, the second continues the premium payments. When the second person dies, then the beneficiaries are paid from the policy. Some of the most common types of policies include the following:

·         Term Life Insurance: This is usually the cheapest option since you are only insured for a certain amount of time, such as the five, 10, or 20 years that you pay the premiums, and it does not build a separate cash reserve.

·         Whole Life Insurance: This insures you for your entire life, as long as you continue making the fixed premium payments. Those payments also build up a cash reserve and serves as a type of investment.

·         Universal Life Insurance: This is similar to whole life except it offers more flexibility in terms of being able to change the amount of life insurance and the premium payments. It also builds a cash reserve.

·         Variable Life Insurance: This allows the policyholder to invest the cash reserves (tax deferred) into stocks, bonds, and securities, with the insurer guaranteeing a certain return on the investment.

Common State Life Insurance Laws

States vary in how they regulate the insurance industry, but some of the more common types of life insurance laws are listed below.

·         Free look periods: These allow a new policyholder to review their policy for a specified amount of time with the option of cancelling it for a full refund.

·         Grace periods: These give a policyholder a certain amount of time to have a past due premium payment before the policy can lapse. It also specifies that beneficiaries must still be paid if the insured dies within the grace period.

·         Timely Payment on Claims: Many states require insurance companies to make payments on a claim within a specified amount of time, or face fines and interest costs.

·         Insurance Guaranties: Many states also maintain a fund that will cover your policy up to a certain amount if your life insurance company goes out of business.

·         Personal information: Some state laws also regulate what insurance companies can do with your personal information.

The Duties of a Life Insurance Company

Each state has its own insurance code that details the specific obligations of insurance companies. However, these companies are generally required to act in good faith and avoid unfair dealing. This includes investigating and paying proceeds within a reasonable timeframe, providing a written explanation for denied claims, and refraining from unfair settlement practices. If you’re dealing with an insurance company who’s acting in an unfair or deceptive manner, you may be able to file a bad faith lawsuit, or pursue a complaint with your state’s insurance commissioner.

Tax Law and Life Insurance Benefits

Tax laws regarding life insurance premiums and proceeds can be complex. Generally, though, premium payments are not deductible, and policy proceeds you receive as a beneficiary are not counted as gross income. However, some proceeds may be subject to an estate tax. For this reason, some estate planners recommend the irrevocable life insurance trust, which can provide the following benefits:

·         Reduces the size of the estate for estate tax purposes

·         Protects the cash value of your policy from creditors

·         Controls when, how, and why your beneficiaries receive policy benefits

·         Helps protect the benefits of a beneficiary receiving government aid

There are a number of ways to set up a life insurance policy with its tax implications in mind. Your individual circumstances and the current federal and state tax laws will dictate what makes the most sense for you.

Is Life Insurance Protected from Creditors?

The answer here again depends on the laws of your state. In some states, creditors can seize the cash value of a life insurance policy if you own it in your own name. In other states, some or all of the cash value and the death benefits are protected from creditors. This is another scenario in which you might set up a trust to protect your assets and the interests of your beneficiaries.

Term Life Insurance

Pros

·         It is relatively inexpensive

·         Various policy terms of coverage are available

Cons

·         It is subject to cancellation

·         Premiums become more expensive as the policyholder ages

The policyholder of term life insurance receives coverage for a certain amount of time specified in the policy. Because it only covers a specified period and the premium only pays for the insurance policy, this is the least expensive type of insurance available. Terms of coverage, for instance, may range from 5, 10, or 20 years. Once the term ends, the policyholder may have the option to renew the policy beyond the original term but the premium usually increases with each renewal.

Depending on the insurance company, a policyholder may have several options under term life insurance. For instance, many policies can be:

·         Renewed: Upon termination, a policyholder may continue coverage by paying a new premium and renewing coverage for a new term.

·         Converted: During the policy term, the policyholder may change from term life to a permanent life insurance option offered by the insurer.

Term insurance is not appropriate for all types of policyholders. For instance, term life insurance may be most beneficial to a person with young children or for a person with temporary expenses, such as a home mortgage or an auto loan. Term insurance is less desirable for a person living off investments and retirement income.

Permanent Life Insurance

Pros:

·         It is not subject to cancellation unless the premium is not paid

·         It endures for the life of the policyholder

·         It is a type of investment

·         Tax benefits may apply

Cons

·         It is expensive

·         Commissions and fees may be high

·         Policies are complex

Permanent life insurance is more expensive than term life insurance because it is effective during the entire life of the policyholder (as long as the premiums are paid) and the excess paid into the policy is invested. In general, the premium remains the same over the entire length of the policy. The excess that accumulates from the premium may yield dividends or interest; the policyholder will receive some of this return. The policyholder can choose to apply the investment income to the reserves, borrow against the cash value, or terminate the insurance policy and receive the cash surrender value. The growth in the value of the reserve is tax deferred under federal tax law, unless the policyholder receives the money. In some cases, a partial withdrawal will escape tax liability.

Permanent life insurance is beneficial for someone with a child with special needs or for someone that expects estate taxes to be high.

The following are the various types of permanent life insurance options:

Whole Life Insurance

Whole life insurance provides the policyholder with lifelong coverage as long as they pay the fixed premium amount throughout their life. In general, the younger the policyholder is when beginning coverage, the less expensive the annual premiums will be. As the policyholder pays into the life insurance policy, the cash reserve continues to build. The policyholder may borrow from the cash reserve at the current policy loan interest rate or surrender the policy and receive the cash value of it.

Universal Life Insurance

Universal life insurance combines flexibility with the accumulation of investment income. The following are the benefits of universal life insurance:

·         Can change the amount of life insurance

·         Can adjust the death benefit and premium payments within the limitations of the policy

·         The account value earns tax-deferred interest

·         The net cost of the policy is less than whole life insurance

·         Can borrow or withdraw money from the cash reserve

Variable Life Insurance

A variable life insurance policy allows the policyholder to invest cash reserves into stocks, bonds, and securities. The policyholder will bear some of the risk, but the insurance company will guarantee a certain return on the investment. Consequently, the death benefit depends on how well the investments perform.

Variable Universal Life Insurance

Variable universal life insurance is a combination of the flexibility of universal life insurance with the investment strategy and the risk factor of variable life insurance.

Single Premium Life Insurance

The policyholder of single premium life insurance will pay the entire premium amount in one up-front payment. The benefits include the immediate accumulation of cash value, the elimination of cancellation, and the distribution of tax-free proceeds to the beneficiaries.

Survivorship Life Insurance

Survivorship life insurance, also referred to as "second to die" insurance, is a single policy that insures two people, usually spouses, for a single insurance benefit. When the first person on the policy dies, the survivor continues making payments on the premium. Only after the survivor dies does the insurance company pay the beneficiaries of the policy.

This insurance policy is appropriate for wealthy couples that expect substantial estate taxes or for people with non-liquid assets like a family business. In this situation, the proceeds from the insurance policy can be used to buyout an ownership interest.