Understanding Life Insurance: Protect Your Practice and Family | Ep. 8

Hi everyone, welcome back to our series of financial planning videos for dental practice owners. This is Ed Leach, Partner and Wealth Advisor and Certified Financial Planner at Highland Financial Advisors. So in the next few videos, we're going to answer a simple question. Are you leaving your practice and your family unprotected? Covering a series of different types of insurances that are really important to incorporate in your personal planning and also for your practice. Today, we're going to kick it off with the topic of life insurance and we're going to answer a few key simple questions. Why do you need life insurance? What are the key differences between term insurance and permanent insurance? And lastly, why life insurance should not be used as an investment. So the first question we're going to answer is why do you need life insurance? The first is a Imagine you've worked really hard to build your practice. You've worked really hard to build a nest egg for your family. Have you ever thought what if something were to happen to you and that income that you're generating from that practice is suddenly turned off for you and your family? You want to make sure that you have an asset that comes in after you are gone to replace not only your lost earnings in that year for the next few years, but the total accumulated wealth that you would have built up over the course of years that you had your practice. In addition, if something were to happen to you, there's a probability if you're a solo practice owner, your practice might not be worth much if you hadn't had a chance to do proper succession planning. And if you are a partner in a practice, there's a chance that the asset is now worth less because you're not there to produce. So life insurance for survivorship needs is very simple, is you want to calculate and answer two questions for how much and for how long. And that's something in working with an advisor and incorporating in your planning are the two key questions that you want to get answered. So the second reason you would need life insurance is for practice planning purposes. In the case if you are a partner in a practice with either several others or just another partner. So in that example, let's say you have two partners in a practice, you each own 50 percent, 50 percent of what is a valuable asset. If something were to happen to either one of you, you'd want the value of that asset transferred to your heirs. But more importantly, you also would not want your spouse to become partners in the practice with your partner if something were to happen to you. So what businesses and dental practices will do is the partners will buy what's called buy-sell insurance. And buy-sell insurance is simply a life insurance policy that each of the partners take out on each other. And if something were to happen to either one of them, the death benefit would be paid out and the proceeds be used to pay out the value of the partner's share to their heirs. Therefore, everyone is made whole and the practice has the ability to succeed the original owners that were there. And lastly, as a reminder, you want to make sure that the buy-sell life insurance that you put in place is coordinated with the attorneys who create your operating agreement or shareholders agreement for the practice. So the second question we want to cover today is what is the difference between term insurance and permanent insurance? So let's start out with term insurance. Term insurance is essentially a type of life insurance that has a set defined period of time that you are covered and you pay policy premiums every single year. And in return, if something were to happen to you during that designated term, your heirs would receive a tax-free death benefit for whatever the face value of the policy is. One of the great features about term insurance is that it allows you to be really precise with your planning and match whatever potential survivorship liabilities that you think you may have, also plan for whatever buy-sell life insurance liabilities that you might have, and match the term of the life insurance policy to the term of what you think that liability will be. So for example, if you're in your 20s and 30s just starting out, you may have some kids, you may have a home with a mortgage on it, odds are the duration of your life insurance need is going to be probably pretty long, maybe 20 or 30 years. However, if you're in your early 50s to mid-50s, maybe you have some liabilities that you still want to be covered, maybe your duration of need is only about 10 years. And lastly, for term life insurance, it's traditionally very affordable and cost-effective to maximize the available death benefit you need for your planning and paying a minimal amount of premium. The reason for this is, and we'll get to this in the next section, is it's not a permanent life insurance need. Again, it really drives the premiums down and it's a really great planning tool to use for survivorship needs. The second type of insurance is permanent insurance, and this is exactly what it sounds like. It's you take out a life insurance policy that is guaranteed to be there at your age 100, 120, it's guaranteed to be there for the rest of your life and pay out to your heirs when you pass away, no matter the age. You pay a premium over that set period of time. Now, one of the drawbacks of permanent life insurance is that it can be very expensive because the life insurance company is essentially guaranteeing that at some point in the future, your heirs will be paid out of benefit. So that's going to come with a cost. When it comes to permanent life insurance, one of the traditional often talked about features is that it accumulates a cash value benefit, meaning that when you make your premiums, you'll see an actual value on your statement of cash value start to accumulate. Now, with permanent life insurance, the way that this cash value worked is that it's traditionally talked about as a tax-free investment. However, what's really happening is over time as you pay your premiums and that cash value accumulates and you receive your interest and dividends, which can either be used to purchase more insurance within the policy or go right to your cash value, that cash value is going to accumulate. And at your age 100 or at some point in the far future, your cash value and the death benefit are set to equal one another. So essentially what is happening is you are using a forced savings vehicle to self-insure a death benefit at some point in the future. It's otherwise known as a sinking fund. You build up a pool of cash inside of a life insurance policy and at age 100 or north of that, that cash value is going to match your death benefit. Hence, when we get to the next section and we talk about why life insurance is traditionally not really good as an investment vehicle, we'll talk more about this. With that being said, permanent life insurance serves really one purpose and that's for an estate planning tool. If you have an estate tax issue, oftentimes families will take out permanent life insurance, put it inside of a trust and use that trust at the time they pass away to replace the lost value of what is paid out in either state or federal estate taxes. At this point in time with where exemptions are, it's very unlikely that you've accumulated the wealth required for that. However, it is a great tool for that purpose. So the last question that we want to answer today is really why life insurance should not be viewed as an investment vehicle. Traditionally, permanent insurance is usually sold as life insurance with the benefit of it will help grow your wealth. The reality is whenever you buy insurance, it's not an investment vehicle. It's essentially a transfer of risk, meaning that I will pay this premium and I will put the risk of me passing away onto the life insurance company and in return, I'll receive a death benefit. Historically, permanent life insurance was viewed as an investment vehicle. It was really one of the only alternatives that people had outside of a savings account or a CD at a local bank in order to get a diversified investment return. Now things are different. You can easily set up an investment account, buy a portfolio of low cost ETFs, stocks, bonds, and put together your own asset allocation to help grow your wealth. Why is permanent life insurance still talked about as a potential investment vehicle? And the reason is for that cash value. However, when reviewing these permanent policies, you're typically shown what's an illustration. And the illustration is going to have really what is two columns, a guaranteed column or the guaranteed return the life insurance company is offering you on your accumulating cash value and a non-guaranteed return. The non-guaranteed return is an assumption the insurance company has made, which is more often than not and always higher than the guaranteed benefit. However, the non-guaranteed benefit is exactly what it is. It's not guaranteed. It's no different than looking at the guaranteed investment return on your savings account or a CD and looking on the non-guaranteed returns of the stock market. Obviously, the stock market has a higher expected return, but it isn't guaranteed. It's no different. So when you're looking at these policies, the question that you want to ask yourself is, why should I pay these additional administrative costs and higher fees just to get access to it as an investment vehicle inside my life insurance policy that also so happens to carry higher insurance costs? It's really not a great investment. And one of the biggest drawbacks as permanent insurance as an investment vehicle is the lack of liquidity. You can't just go to the life insurance company and say, hey, send me a few thousand dollars. I need to pay tuition for my child. The only way for you to get access to that cash value is either surrendering the policy, which is not what you want to do, especially if you need life insurance as a death benefit, or taking out a loan, which is going to cost you money and you're going to be paying interest to that life insurance company. So when you put all those factors together, life insurance, specifically permanent life insurance, is not a great investment vehicle. Insurance should really be mainly viewed as a transfer of risk. So in this video, we answer the three key questions of why do you need life insurance? What is the difference between term and permanent insurance? And why permanent insurance is not traditionally viewed as a great investment vehicle. One of the things that we do at Highland, the way that we approach life insurance planning is using term insurance and spending the time with clients to really understanding the duration of the need for survivorship. That could be looking at how old your children are. When will they be graduating college? When will the mortgage be paid off? When will those student loans be paid off? Looking at the whole view of not only you, but also your spouse and understanding all the risks to your family is the way that we approach it. Then and only then can we answer the two questions of how much for how long. And one of the most cost effective ways to get the life insurance is by laddering term policies. You may have a policy for 10 years, one for 20 years and one for 30 years. And what that does is allow you to not pay for life insurance for any more than the time that you probably need it. It also allows you to maximize death benefit and create leverage for yourself in the early years when more than likely you need the most death benefit. So I hope you'd enjoyed this video. Hit subscribe down below to get notified when our next video comes up. And next time we'll be talking about disability insurance. Thank you so much and talk to you soon.