Must Read: What to Know About Life Insurance, its Benefit and Damage.

Life Insurance/Assurance.

Life insurance or life assurance, especially in the Commonwealth, is a contract between an insurance policy holder and an insurer or assurer, where the insurer promises to pay a designated beneficiary a sum of money (the benefit) in exchange for a premium, upon the death of an insured person (often the policy holder). Depending on the contract, other events such as terminal illness or critical illness can also trigger payment. The policy holder typically pays a premium, either regularly or as one lump sum. Other expenses (such as funeral expenses) can also be included in the benefits.

Life policies are legal contracts and the terms of the contract describe the limitations of the insured events. Specific exclusions are often written into the contract to limit the liability of the insurer; common examples are claims relating to suicide, fraud, war, riot, and civil commotion.

Life-based contracts tend to fall into two major categories:

·         Protection policies – designed to provide a benefit, typically a lump sum payment, in the event of specified event. A common form of a protection policy design is term insurance.

·         Investment policies – where the main objective is to facilitate the growth of capital by regular or single premiums. Common forms (in the U.S.) are whole life, universal life, and variable life policies.

Advantages & Disadvantages of Life Insurance

Life insurance offers several advantages not available from any other financial instrument; yet it also has disadvantages.

Advantages of Life Insurance

·         Life insurance provides an infusion of cash for dealing with the adverse financial consequences of the insured's death.

·         Life insurance enjoys favourable tax treatment unlike any other financial instrument.

·         Death benefits are generally income-tax-free to the beneficiary.

·         Death benefits may be estate-tax free if the policy is owned properly.

·         Cash values grow tax deferred during the insured's lifetime.

·         Cash value withdrawals are treated on a first-in-first-out (FIFO) basis, therefore cash value withdrawals up to the total premiums paid are generally income-tax free.

·         Policy loans are income tax free.

·         A life insurance policy may be exchanged for another life insurance policy (or for an annuity) without incurring current taxation.

Note: All of the above statements are generally true; however the tax benefits of life insurance have certain limitations which under the wrong set of circumstances can cause the tax benefits mentioned to be lost.  Please discuss with your insurance and tax advisor.

·         Many life insurance policies are exceptionally flexible in terms of adjusting to the policyholder’s needs.  The death benefit may be decreased at any time and the premiums may be easily reduced, skipped or increased.

·         A cash value life insurance policy may be thought of as a tax-favoured repository of easily accessible funds if the need arises; yet, the assets backing these funds are generally held in longer-term investments, thereby earning a higher return.

Disadvantages of Life Insurance

·         Policyholders forego some current expenditure to pay policy premiums.  Moreover, life insurance is typically purchased for the benefit of others and usually only indirectly for the insured person.

·         Cash surrender values are usually less than the premiums paid in the first several policy years and sometimes a policy owner may not recover the premiums paid if the policy is surrendered.

·         The life insurance purchase decision and the positioning of the life insurance can be complex especially if the insurance is for estate planning, business situations or complex family situations.

·         The life insurance acquisition process can be annoying and perplexing (e.g. is the life insurance agent trustworthy?  Is this the right product and carrier?  How can medical underwriting be streamlined?).