Why Insurance Policies Blow Up
Over the last fifteen years, many seniors have purchased insurance policies as an estate-planning device. They obtain the insurance to pay estate taxes due. That way, the remaining estate can pass to their beneficiaries intact and avoid the erosion of taxes. However, some of these life insurance policies have “blown up” and a little understanding can help you avoid this circumstance.
A gentleman recently told me he approached an insurance agent about a $1 million policy. The agent told him the premium would be $25,000 annually. When he told the agent that the premium was too high, the agent responded that he could knock the premium down to $12,000. How can the same policy be available for half price? The lower price is not the same policy and here’s what’s confusing about insurance. When you get life insurance, you will always be given a “guaranteed” column of numbers and a “projected” column. The projected column is based on today’s interest rates.
When you purchase an interest-sensitive life insurance policy, the assumption is that the cash value account within the policy will generate enough interest to help pay the future premiums. However, that may not be the case and that’s why policies can blow up.
If rates hold steady or increase, there will be sufficient interest earnings on the cash value account to keep the policy in force. However, if interest rates fall, you can only count on the guaranteed column of figures. Often, the guaranteed column may show that the policy “blows up” at age 90. If you live beyond 90, the insurance won’t be there (assuming that interest rates fall to the guaranteed level and stay there). The guaranteed column is your “worst case” scenario. If you want the guaranteed column to show that your policy will still be in force if you make it to 100, then you’ll pay a higher premium for that assurance.
Therefore, you can get a policy that looks the same for half price, but it has more risk of running out before you do. Life insurance can be a great way to pay off estate taxes at a discount, but make sure you understand that the best “quote” may not be your safest quote.
If you’ve purchased a policy in the last fifteen years, while interest rates have been declining, get a “policy ledger” from the company and review it. The ledger reveals and warns you if your policy may run out before you do.