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Life Insurance: Death Benefit Types [Video]
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This is video three of our four part series. If you haven’t had an opportunity to watch the first two I would encourage you to spend some time watching those videos as we are going to refer to a couple of things we talked about there. Also another quick disclaimer, at Financial Design Studio, Inc. we do not sell any life insurance, but we do review it as a part of each clients financial plan because of how critical of an aspect it is. Today’s video is all about death benefits and face amounts.
When you originally purchased your policy you were probably told that you were purchasing X number of thousands of dollars of insurance. Were you also told what the death benefit option may be. We will go through an example here in a moment so you can see why it's so important.
Death Benefit Example
John purchased a contract 10 years ago. That was for a $500,000 contract and required premiums of $3500/year. Let's say today the cash value on that contract is $48,000. Simple straight forward examples. The interesting part is depending on the death benefit option his beneficiaries could receive one of three different numbers. This is depending on which death benefit option was chosen.
Amount Beneficiaries Receive
Contract A-$500,000
Contract B- $548,000
Contract C- $535,000
What is the difference with these contracts?
Option A contracts are what's considered a level death benefit option. This means no matter what the cash value of the contract is the beneficiaries will always be paid the face amount. In this case $500,000.
With the B contract it is called increasing, meaning as the cash value on the contract grows and so does the death benefit option that gets paid out. In this case we are looking at $500,000, the face amount, plus the cash value of $48,000 totalling $548,000.
Option C contracts are considered a return of premium. In this case since we paid in 10 years of $3500 premium that means we paid $35,000 in premiums we get to $535,000.
What is the best contract?
You might think that option B is going to be the best because it results in the highest death benefits to your beneficiaries. While that could be the case sometimes that doesn’t always mean it's the best for you and your family. If we step back and think about it instead of paying for the $500,000 of life insurance with an option A contract we are actually only paying for $452,000. How? The reason why is because we have a face amount of $500,000 the insurance company is keeping our $48,000. In reality our cost of insurance is based off of this $452,000 opposed to $500,000.
This is really important as you age and continue to get older chances of your death become higher and higher. So as you get older you are more likely to die so your cost of insurance is going to increase as you get older. As you have an option A contract the cost of insurance may actually slowly come down, because you have an increasing cash value to offset the increased cost of insurance. Which means for a later in life policy the option A contracts can make a lot of sense because they don’t get cost prohibited as they would on an option B contract. Figuring the best contract for you means going through your entire financial plan and determining what makes the most sense for you and your family.
Considerations for Contracts
Let's talk through a quick planning point and consideration we can think through today. Let's say that with this contract a great feature that we talked about before with permanent policies is there is a cash value associated with them. If that cash value is offering to pay us 4% a year. That is actually really nice if we compare that to a checking or savings account it can be really challenging to match that in those accounts as well. If we want to fully utilize that how would we go about doing that with the least amount of risk possible.
You may think with the option A contract if we add a lot of money to our insurance policy. For example if we add $20,000 to our cash value we are reducing the cost of our insurance and we are capturing the 4%. Here's the catch if something were to happen to you and you were to die shortly after you add the $20,000. Your family would be left without that $20,000 in your bank account that they would have otherwise had. In a situation like this when we are reviewing this policy we may offer to the client to transition your policy from an A to a B policy. The reason is as we add our $20,000 to the cash value even though we are paying more for the cost of the insurance we are always protected because the $548,000 is our cash value plus the face amount of the contract. This may not always be the case. We may want to look at an option C policy instead, but it is something to be mindful of instead of just going out and trying to utilize our contracts we may have purchased in years past.
When you originally purchased your policy you were probably told that you were purchasing X number of thousands of dollars of insurance. Were you also told what the death benefit option may be. We will go through an example here in a moment so you can see why it's so important.
Death Benefit Example
John purchased a contract 10 years ago. That was for a $500,000 contract and required premiums of $3500/year. Let's say today the cash value on that contract is $48,000. Simple straight forward examples. The interesting part is depending on the death benefit option his beneficiaries could receive one of three different numbers. This is depending on which death benefit option was chosen.
Amount Beneficiaries Receive
Contract A-$500,000
Contract B- $548,000
Contract C- $535,000
What is the difference with these contracts?
Option A contracts are what's considered a level death benefit option. This means no matter what the cash value of the contract is the beneficiaries will always be paid the face amount. In this case $500,000.
With the B contract it is called increasing, meaning as the cash value on the contract grows and so does the death benefit option that gets paid out. In this case we are looking at $500,000, the face amount, plus the cash value of $48,000 totalling $548,000.
Option C contracts are considered a return of premium. In this case since we paid in 10 years of $3500 premium that means we paid $35,000 in premiums we get to $535,000.
What is the best contract?
You might think that option B is going to be the best because it results in the highest death benefits to your beneficiaries. While that could be the case sometimes that doesn’t always mean it's the best for you and your family. If we step back and think about it instead of paying for the $500,000 of life insurance with an option A contract we are actually only paying for $452,000. How? The reason why is because we have a face amount of $500,000 the insurance company is keeping our $48,000. In reality our cost of insurance is based off of this $452,000 opposed to $500,000.
This is really important as you age and continue to get older chances of your death become higher and higher. So as you get older you are more likely to die so your cost of insurance is going to increase as you get older. As you have an option A contract the cost of insurance may actually slowly come down, because you have an increasing cash value to offset the increased cost of insurance. Which means for a later in life policy the option A contracts can make a lot of sense because they don’t get cost prohibited as they would on an option B contract. Figuring the best contract for you means going through your entire financial plan and determining what makes the most sense for you and your family.
Considerations for Contracts
Let's talk through a quick planning point and consideration we can think through today. Let's say that with this contract a great feature that we talked about before with permanent policies is there is a cash value associated with them. If that cash value is offering to pay us 4% a year. That is actually really nice if we compare that to a checking or savings account it can be really challenging to match that in those accounts as well. If we want to fully utilize that how would we go about doing that with the least amount of risk possible.
You may think with the option A contract if we add a lot of money to our insurance policy. For example if we add $20,000 to our cash value we are reducing the cost of our insurance and we are capturing the 4%. Here's the catch if something were to happen to you and you were to die shortly after you add the $20,000. Your family would be left without that $20,000 in your bank account that they would have otherwise had. In a situation like this when we are reviewing this policy we may offer to the client to transition your policy from an A to a B policy. The reason is as we add our $20,000 to the cash value even though we are paying more for the cost of the insurance we are always protected because the $548,000 is our cash value plus the face amount of the contract. This may not always be the case. We may want to look at an option C policy instead, but it is something to be mindful of instead of just going out and trying to utilize our contracts we may have purchased in years past.
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