A common question that I am asked during the estate planning or business succession planning process is “Do you believe in life insurance?” The question is usually quickly followed by a reference to Dave Ramsey and his stance on cash value life insurance. While many things Mr. Ramsey says have great value, I think his position on life insurance is overly simplistic. Life insurance is a unique tool in that it serves numerous diverse functions. If the question is simply one of leaving a legacy or income replacement, I would tend to agree. Go with the least expensive term policy you can find and invest the difference. The problem with the term insurance is the fact that the low price you pay is only good when you are young. As you get older, term insurance premiums can become very expensive and may not be sustainable.
If it is essential that the policy stay in effect regardless of how long you live, a permanent policy where the premium is fixed or even gets paid by the cash value at some time may make sense. When would this be the case? While there may be others, here are a few examples:
- Funding a buy-sell agreement – A buy-sell agreement funded with life insurance is often the most economical and practical solution when a business owner dies. If you use life and/or disability income insurance to fund the obligations under the arrangement, you can be assured that CASH will be available when you need it. Life insurance also covers the risk of premature death by providing an immediate death benefit that is generally received free of federal income tax at the death of the insured owner.
- Wealth Replacement – Life insurance can provide the liquidity to pay estate taxes after death. Life insurance can also be used to replace the value of gifts to charity or non-family members.
- Estate Equalization – life insurance can provide the means to equalize distributions to other children when one child is receiving a significant asset such as a family farm or other business.
These are just a few examples that demonstrate the need for life insurance that may continue beyond the sustainability of a term insurance policy.
So how do I respond when asked the question, “Do you believe in life insurance?” I respond that it is not a religion that is to be believed in or not. It is a tool. If the tool works, then it makes sense to consider and possibly use the tool. If it doesn’t work, then it should not be used. Be wary of any advisor who thinks life insurance is always the answer or never the answer. Both dogmas are misplaced and will lead to poor planning.