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Four mistakes with life insurance you don’t need (or want) to make

Jun 19, 2023

Permanent or term, purchasing insurance can be distressing and mind-boggling—but oh-so-necessary for your family’s future well-being

Those who have significant wealth, and financial wisdom, often use life insurance for so much more than merely to replace income. They use it to create liquidity to pay estate taxes, leave a legacy, transfer wealth tax-efficiently, ensure that a business succession plan succeeds—and more.

Yet many people shy away from incorporating life insurance into their financial plans, occasionally to their—and their families’—later regret. And that is just one of the mistakes we see those people make with their insurance coverage. We also see them failing to purchase coverage adequate for their needs, naming the wrong owner for the policy, neglecting to integrate their life insurance into the rest of their financial planning and forgetting to keep policies up-to-date.

It’s easy to see why so many people avoid even thinking about life insurance: It forces us to contemplate our mortality or that of loved ones. It also can be difficult for anyone who is not in finance or the life insurance business to fully understand the economic features of policies (such as the differences among types, the significance of interest rates, and the consequences of late or unmade premium payments). Typically, the wealthier an individual is, the more complicated the family’s finances and the greater the need for life insurance can be.

You don’t want to leave your family in the lurch, perhaps scrambling to pay the taxes due on your estate or being forced to sell the family business. And there are experts to help you get it right. So here’s how to make sure you have adequate life insurance for your needs. Step one: Avoid these four common mistakes.

We recommend working with your advisor to determine how much your beneficiaries will truly need, depending on the intention for your wealth, evolving needs and timing.

For example, they may need a certain amount to continue to live the lifestyles to which they are accustomed, or they may need to pay off a mortgage, finish schooling, maintain a family vacation home, offset estate taxes, make charitable donations or generate cash to continue running a business.

On average, individuals with a net worth of around $100 million typically require a death benefit of about $25 million–$50 million; obviously, the greater a net worth, the larger the policy size might be.

If your policy has the wrong owner, your beneficiaries could end up with only about half of the amount you wanted them to have.

That’s possible because, while a life insurance policy’s death benefit passes generally free of income taxes to the beneficiary, it could be subject to estate taxes. If the insured is also the owner of the policy, on his or her death, the death benefit would be included in the insured’s estate, and therefore subject to U.S. estate tax of up to 40%. In addition, the death benefit could be subject to state estate taxes at rates of roughly 10%—for an all-in estate tax burden of up to 50% or more.

Our thoughts: Consider making an irrevocable trust the owner of the policy. Typically, the insured establishes the trust, then transfers cash equal to the annual life insurance premiums into it.

Indeed, it’s our observation that irrevocable trusts own most of the permanent (as opposed to term) policies that are insuring the lives of the Private Bank’s clients.

A permanent insurance policy often has fairly well-defined return and risk features that can be evaluated as part of a family’s overall balance sheet. Also, the policy’s owner can borrow against the policy as needed and exercise other ownership rights (such as changing beneficiaries) granted under the terms of the insurance contract.

Our thoughts: Because permanent policies often include an investment component, they should be included as part of your family’s overall asset allocation and reviewed on a regular basis to ensure that your allocation continues to align with your goals.

For instance, if an elderly family member is the insured of a policy that has a sizeable death benefit, the family might want relatively more of the family’s assets invested in equities, rather than bonds. That’s because of the high likelihood that the family will have a significant influx of cash on the client’s passing. The cash could supply sufficient ballast to the family’s overall portfolio.

Just as market conditions can affect your investments, macroeconomic and interest rate environments can affect permanent life insurance cash values, possibly leading to a different outcome than you might have expected. These surprises are more likely to happen if you borrow against the policy’s cash value or take distributions from it.

Many insurance contracts provide that if a certain dollar amount in premiums is paid over a certain number of years, a certain death benefit would be paid on the death of the insured. However, that death benefit may differ from the illustrations you’ve been shown because those illustrations were based on assumptions about interest rates, and interest rates did something else. 

The financial strength of the insurance company behind your life insurance policy also can influence your policy’s outcome, especially if the return on your cash value “investment” is based on how well the company’s investments perform.

All these factors can cause fluctuations in the value of your life insurance policy.

Our thoughts: Any sizeable policy should be evaluated at least annually as a matter of good financial hygiene

Your J.P. Morgan team can help you assess how life insurance could fit into your estate and financial plan, select a term or whole life insurance policy that would meet your needs and those of your beneficiaries, and conduct a policy review to ensure that it continues to align with your goals.

JPMorgan Chase & Co., its affiliates, and employees do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for tax, legal and accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any financial transaction.

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Investing involves market risk, including possible loss of principal, and there is no guarantee that investment objectives will be achieved. Past performance is not a guarantee of future results.

Asset allocation/diversification does not guarantee a profit or protect against a loss.

Withdrawals of taxable amounts are subject to ordinary income tax and, if taken prior to age 59½, an additional 10% federal tax may apply. Keep in mind, for retirement plans and accounts (such as IRAs and 401(k)s), an annuity provides no additional tax-deferred benefit beyond that provided by the retirement plan or account itself.

Annuities are long-term investments designed to help meet retirement needs. They are a contractual agreement where a client makes payments to an insurance company, which, in turn, agrees to pay out an income stream or a lump sum amount at a later date. Annuities typically offer (1) tax-deferred treatment of earnings; (2) a death benefit; and (3) annuity payout options that can provide guaranteed income for life. There are contract limitations, fees and charges associated with annuities which include, but are not limited to mortality and expense risk charges, sales and surrender charges, administrative fees, charges for any optional benefits, and charges for the underlying investment options in variable annuities. In addition, variable annuity contract values will fluctuate and are subject to market risk including the possible loss of principal. It is possible to lose money in a variable annuity purchased with an optional protection rider. Variable annuities have holding periods, limitations, withdrawal charges, exclusions, termination provisions, and terms for keeping them in force. Optional riders may be irrevocable and expire without use. Early withdrawals may be subject to surrender charges, and taxed as ordinary income, and in addition, if taken prior to age 59½ an additional 10% federal tax may apply. Withdrawals reduce annuity contract benefit, values and optional guarantees in an amount that may be more than the actual withdrawal.

It is important to note that indexed annuity contracts commonly allow the insurance company to change the participation rate, cap rate, and/or spread rate on a periodic — such as annual — basis. Such changes could adversely affect your return. No single index crediting method will provide the highest interest credit in all market scenarios. The guaranteed minimum cap rate/maximum spread rate are established when the annuity is purchased and disclosed in the annuity contract.

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