Ways to fit life insurance into your financial plan: insights from an expert

Life insurance is more than just a safety net for your loved ones; it’s a powerful tool that could significantly enhance your financial health. Whether you’re looking to secure your family’s future or create a robust financial plan, understanding the role of life insurance is crucial.

I’m Ashlyn Brooks, a personal finance and insurance writer with nearly a decade of experience. Navigating the world of finance wasn’t always easy for me. Growing up, financial literacy wasn’t a common topic, so I had to learn the hard way how to manage money effectively. These experiences fueled my passion for making financial concepts accessible and relatable to everyone.

Life insurance can be perplexing for many people. To get an expert’s opinion on how life insurance can fit into the average American’s financial plan, I turned to Tony Steuer, CLU, LA, CPFFE, an accomplished author, podcaster and financial preparedness advocate, and a member of Bankrate’s expert review board. Steuer’s journey began at his first job, where he noticed a common problem: many people didn’t understand the financial products they were purchasing and lacked healthy money habits. This realization drove him to focus on financial education and best practices.

Steuer recognizes the challenges everyday people face. He states, “Organizing and planning your financial life can be overwhelming, especially with advice coming from all directions.” In order to take control of finances and feel empowered, he acknowledges that people need straightforward approaches and minimal insurance jargon.

In this article, we’ll explore how to use life insurance and how it can be a cornerstone of your financial strategy, offering practical insights from Steuer to illustrate the role insurance can play in financial planning.

What is financial planning?

Financial planning is essential for everyone, regardless of their financial situation. It’s not just for the wealthy or those struggling financially. Everyone can benefit from having a structured plan to manage their finances effectively. Financial planning involves creating a roadmap to achieve your financial goals and secure your financial future.

Here are a few basic, although essential, areas of financial planning:

• Budgeting: Managing income and expenses to ensure you live within your means.
• Saving: Setting aside funds for future needs and emergencies.
• Investing: Growing wealth through various investment vehicles.
• Insurance: Protecting against unforeseen risks with appropriate insurance policies.
• Retirement planning: Ensuring you have enough resources to maintain your lifestyle in retirement.
• Estate planning: Preparing for the distribution of assets after death.

Financial planning isn’t just about having a plan; it’s about making informed decisions to improve your financial health. According to Bankrate’s recent Financial Independence Survey, 61 percent of parents with adult children are currently sacrificing, or have sacrificed, their financial stability to help their kids, often risking their own retirement savings or emergency funds. This underscores the importance of having a financial plan that balances current needs with future security.

The survey also revealed that 49 percent of adults aged 23 or older who say they currently receive or have received ongoing financial assistance from their parents received help with housing. Additionally, 48 percent of those adults received assistance with everyday expenses like groceries and utilities. This trend highlights the need for improved financial literacy and planning, especially among younger generations who face significant financial challenges due to high living costs and economic pressures.

By understanding and implementing key areas of financial planning, you can help create a secure financial future for yourself and your family. One critical aspect of a comprehensive financial plan is life insurance, which can play a pivotal role in safeguarding your financial health.

What role does life insurance play in financial planning?

Life insurance is often seen merely as a means to provide for loved ones after death, but its role in financial planning is much broader. By leveraging tax benefits, supporting long-term care needs, ensuring debt protection and enhancing retirement planning, life insurance could significantly impact your overall financial health. Let’s dive into the invaluable insights Tony Steuer provides about how life insurance can be integrated into a comprehensive financial plan.

Leveraging tax advantages

Imagine a young family aiming to secure their financial future. They purchase a life insurance policy not only for protection but also for its tax benefits. The death benefit from this policy is received tax-free, ensuring financial support without additional tax burdens. Additionally, the policy’s cash value grows tax-deferred, offering a potential source of funds for future expenses like college tuition or emergencies without immediate tax implications.

Steuer explains that the death benefit from a life insurance policy is typically not subject to income tax, and the cash value grows on a tax-deferred basis. This means no income tax is due on the cash value until it is withdrawn. You can generally withdraw up to your cost basis (the sum of premiums paid) without paying income taxes. Any amount above the cost basis is taxed as ordinary income. Additionally, borrowing from the policy does not incur income tax, but you will pay interest on the borrowed amount. If the policy lapses with an outstanding loan, income tax will be due on the amount that exceeds your cost basis.

Supporting long-term care needs

Consider a couple in their 50s as they plan for retirement. They may worry about potential long-term care costs that could deplete their savings. By choosing a hybrid life insurance policy with long-term care benefits, they can have peace of mind knowing they are protected. This policy not only offers a death benefit to their beneficiaries but also ensures they have coverage for any future care needs without jeopardizing their retirement nest egg. This way, they can enjoy their retirement years with the assurance that they are prepared for any health-related expenses.

Steuer suggests that if you have no need for life insurance, it is better to purchase a standalone long-term care insurance policy. However, if you need both, consider a hybrid policy that provides a death benefit, cash value and long-term care benefits or a permanent life insurance policy with a long-term care rider. It’s crucial to compare both types to determine what best fits your needs.

Ensuring mortgage and debt protection

A young family just bought their dream home with a substantial mortgage. To protect against the risk of losing their home if one of the parents unexpectedly passes away, they secure a life insurance policy. This policy ensures that if the unthinkable happens, the death benefit can be used to pay off the mortgage. This can help provide peace of mind and financial stability, allowing the surviving family members to stay in their home without the added burden of mortgage payments.

Steuer emphasizes that the death benefit from a life insurance policy can be used to either pay off the mortgage or cover monthly mortgage payments. It is important to evaluate whether paying off the mortgage in one fell swoop is the best option for your family’s financial situation or to use that money elsewhere. There aren’t any restrictions as to how a beneficiary can use death benefit proceeds.

Enhancing retirement planning

A couple, Jane and Mike, are empty nesters making plans for their retirement years. They have already maxed out their contributions to traditional retirement accounts. To further secure their financial future, they decide to purchase a permanent life insurance policy with a cash value component. Over the years, the cash value grows, and by the time they retire, they have built up a substantial amount.

Their children are financially independent, so besides leaving a small amount for funeral expenses, Mike and Jane can take advantage of their life insurance policies by accessing the built-up cash value for themselves through policy loans. They can use these funds to supplement their retirement income, ensuring they have enough to travel, enjoy hobbies and cover unexpected expenses, making their retirement years truly golden.

While policy loans plus accrued interest need to be paid back at some point, it’s not required for policy owners to pay this while they are alive. They can choose to let the balance grow and allow the insurer to deduct it from the death benefit before their adult children, the policy beneficiaries, receive payouts.

Policyholders can also make withdrawals from some permanent life insurance policies, such as Universal Life, Variable Universal Life and Equity Indexed Universal Life. Policy withdrawals are distributions from the policy and are not paid back. Policy withdrawals generally reduce the death benefit on a dollar-for-dollar basis. For example, a withdrawal of $50,000 will reduce the death benefit by $50,000. Because policy withdrawals are distributions, they do not accrue interest.

Steuer explains that the cash value in a life insurance policy is not subject to income taxes since premiums are usually paid with after-tax dollars. However, he cautions that managing distributions is crucial, as any cash withdrawn or borrowed will reduce the death benefit, and excessive policy loans can erode the policy.

A deeper understanding

To provide more clarity, Steuer offered a deeper dive into one specific type of policy: Equity Indexed Universal Life (EIUL) insurance policies. This is a permanent policy with cash value potential that is popular in the market right now. Here’s how it works in simpler terms:

• Tied to stock market index: These policies link your earnings to a stock market index, like the S&P 500, but with certain limits.
• Earnings cap: Even if the index earns a high return, say 15 percent, your policy might have a cap that limits your earnings to 10 percent.
• Participation rate: Additionally, there is a participation rate, which might be 80 percent. Steuer explains, “This means you only get 80 percent of the capped return. So, if the cap is 10 percent, your actual earning rate would be 8 percent (which is 80 percent of the 10 percent cap).”
• Guaranteed floor: The upside of these policies is that they also have a “floor,” meaning your earnings won’t go below a certain level, often 0 percent, even if the market performs poorly. This way, you won’t lose money due to market downturns, but your potential gains are also limited by the cap and participation rate.

By understanding these components, it can help you make informed decisions about how life insurance can fit into your retirement planning and overall financial strategy. The structured growth potential and protection against market downturns offered by EIUL policies could provide a balanced approach to accumulating retirement funds while ensuring that you have a safety net in place.

It’s important to keep in mind that all life insurance policies will include a charge for the cost of insurance and administrative expenses.

How to incorporate life insurance into your financial plan

Life insurance is more than just a safety net for your loved ones; it’s a versatile tool that can play a pivotal role in your overall financial strategy. Incorporating life insurance into your financial plan can help you achieve a range of financial goals, from securing your family’s future to enhancing your retirement. Let’s explore how to integrate life insurance effectively.

Aligning life insurance with financial goals

To maximize the benefits of life insurance, it’s helpful to align it with your broader financial goals. This involves setting priorities and ensuring your life insurance complements other aspects of your financial strategy.

1. Identify your financial goals:

• Ensure family financial security in the event of your death.
• Save for major expenses like college tuition or a new car.
• Build an emergency fund for unexpected costs.

2. Create a cash flow statement:

• Understanding your income and expenses helps allocate funds wisely.
• Prioritize savings and insurance before discretionary spending.

3. Balance premiums with other priorities:

• Allocate funds to top goals like savings and insurance before spending on leisure activities.
• Adjust lifestyle choices to ensure financial security.

Selecting the right policy

Choosing the right life insurance policy is an important step in ensuring it aligns with your long-term financial goals. Different types of policies offer varying benefits, so it’s beneficial to match the policy type with your specific needs.

1. Determine your need:

• Assess whether you need life insurance to cover temporary needs (like paying off a mortgage) or permanent needs (like providing for a child with special needs).

2. Evaluate policy types:

• Term insurance is ideal for temporary needs, providing coverage for a specific number of years (10–30 years).
• Permanent insurance, such as whole life insurance, is suitable for lifelong needs (maximum coverage age ranging from 95 to 121). It offers a death benefit and accumulates cash value over time.

3. Regularly review your policy:

• Review your life insurance policy annually or after major life events to make sure it continues to meet your needs.
• Monitor performance and adjust premiums as necessary to maintain coverage.

Looking towards the future

The life insurance industry is evolving, with new trends and technological advancements that could further integrate life insurance into comprehensive financial planning.

1. Technological Advancements:

• Accurate risk selection and pricing: Modern technology aids in selecting and pricing risks more accurately. Steuer notes, “Technology helps companies price risks more accurately, benefiting everyone in the long term with appropriate premiums.”
• Enhanced policy owner service: AI can improve service by monitoring policy performance and addressing issues proactively. Steuer explains, “AI could help monitor policies that will have issues such as under-performance.”

2. Changing Perceptions:

• Focus on risk protection: Steuer states, “A key change will be when life insurance is regarded primarily as a risk protection product rather than an investment or asset class.”
• Foundation of financial plans: Consumers should view life insurance as a foundational element of their financial plan, akin to homeowner’s insurance. As Steuer mentions, “With a homeowner’s insurance policy, the policy owner is perfectly happy if no claim is paid and there is no expectation of getting anything back.”

What Steuer means by the homeowners insurance comparison is that when you buy homeowner’s insurance, you’re paying for peace of mind. You don’t hope for your house to catch fire or suffer damage just to get a payout. Instead, you’re content paying the premiums because you know you’re protected against potential disasters. Similarly, life insurance should be viewed as a way to protect your family’s financial future. You might never want to “use” it, but having it ensures that your loved ones are secure if the worst happens.

By understanding these aspects and aligning your life insurance with your financial goals, you can effectively incorporate life insurance into your financial plan, ensuring comprehensive financial security and peace of mind.

Bottom line

Life insurance and risk protection are foundational to a sound financial plan, yet they are often overlooked. This oversight can stem from a lack of understanding or the daunting nature of insurance discussions. However, integrating life insurance into your financial strategy can be beneficial for comprehensive risk management.

Steuer emphasizes that life insurance should not be viewed in isolation but as an integral part of overall financial planning. “People need to think about the risks they have and then protect against them,” he states. This proactive approach ensures that your family’s financial future is secure, even in unforeseen circumstances.

One common issue is the misconception that everyone needs life insurance, leading some to purchase policies prematurely. Steuer explains, “The theory is that they should buy it when young and healthy. However, this ignores the fact that some people will never have a need for life insurance. The key shift will be when people change the way they think about life insurance. They often think about the product first, rather than their needs.”

Incorporating life insurance into your broader financial plan is more than just a financial decision — it’s a commitment to your loved ones and their future. Regular reviews and adjustments ensure that your coverage evolves with your changing needs, providing a sense of security and peace of mind. Imagine the reassurance of knowing that, no matter what life throws your way, your family will be protected and supported.

This proactive approach to financial planning isn’t just about safeguarding assets, it’s about fostering a legacy of care and responsibility. By making life insurance a central part of your financial strategy, you can help make sure that your family’s future is secure and that their dreams remain within reach.