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Texas Life Insurance Coverages Explained

Texas Life Insurance

Texas Life insurance helps protect the people who depend on you for financial support by replacing some or all of your lost income when you die. It can help pay expenses that your income normally would have covered, including mortgage payments, bills, and a dependent’s child care or college tuition. Some types of life insurance also accumulate cash value during the policyholder’s lifetime that can be withdrawn or borrowed against.

Texas Life Insurance Basics

When you buy a Texas life insurance policy, you specify whom you want to receive the policy’s death benefits when you die. The people you specify are called “beneficiaries.” It’s important to understand that the primary purpose of life insurance is to help your beneficiaries maintain their standard of living after you die. Life insurance isn’t an investment. A life insurance policy is generally guaranteed to pay death benefits when the policyholder dies. With an investment, however, there’s a risk to the payoff – an investor might earn money, but he or she also might lose some or all of it.

While some types of Texas life insurance include a savings component that can provide some retirement income, Texas law prohibits marketing life insurance as an investment or retirement income source. If an agent or company tries to sell you a life insurance policy as a good investment, be careful. Complicating matters somewhat, many life insurance companies also sell a legitimate investment product called “annuities” that are similar in principle to life insurance. People often purchase these investments to provide for retirement because they can provide a steady stream of income over a long period of time.

Insurance companies use a process called “underwriting” to determine which policy applicants to accept and what premium rates to charge. The company will consider certain “risk factors,” including your age, gender, medical condition, and whether you smoke. Younger applicants who are in good health and who don’t smoke will generally be charged lower premiums. The insurer expects that these policyholders will live longer and thus be able to make more premium payments. Older applicants who have health problems or those who smoke can expect to pay significantly more because their risk of early death is statistically higher. Some companies may determine that, based on its review of an applicant’s risk factors, the applicant is too great a risk and may decline to issue coverage altogether.

If a company declines to cover you or charges you more for coverage because of your health status or other factors, keep shopping. Different companies have different underwriting guidelines. If you are accepted for coverage at a higher rate, ask whether your premium can be lowered later. Some companies will lower your premium if you maintain good health for a specified period of time, give evidence that your health has improved, or change to a less-hazardous occupation.

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The Main Types of Texas Life Insurance

Life insurance can generally be classified as either “term life,” “cash value life,” or a combination of the two. Term life coverage is typically less expensive and less complex. These policies pay only once – with a specified death benefit when the insured dies – and only if the person dies during the specified term that the coverage is in force. Cash value life policies typically provide a variety of features and benefits in addition to the death benefit, and they typically cost more. The key feature of all cash value life insurance is a savings component that accumulates over time and may be withdrawn, invested, or borrowed against during the policyholder’s lifetime, depending on the policy terms.

Texas Term Life Insurance

Term life policies take their name because coverage only lasts for a specific period of time – such as 15, 20 or 30 years – or until the insured reaches a certain age. The cost of term life generally increases as you get older. For people under age 40, term life generally provides the largest death benefit per premium dollar of any type of life insurance.

Term life policies typically don’t include a savings component. If you die during the term, the insurance company pays the amount of the death benefit specified by the policy. If you don’t die during the term, the policy lapses, no benefit is paid, and you must either renew or purchase another type of coverage if you wish to keep life insurance.

Term life can be a good choice for young families with children. You may only need coverage until the children are old enough and financially able to provide for themselves. Common features of most term life policies include:

Convertibility:

You can exchange the policy for permanent life insurance of equal value without taking a medical exam or any further underwriting. For example, you could transfer a $100,000 convertible term policy into a $100,000 cash value policy without having to answer questions about your health or medical history. However, your premium will probably increase because cash value coverage typically costs more than term life. Convertibility can be an important feature if your health declines and you become unable to qualify for a permanent policy through a separate application. Converting to a cash value policy can also allow you to begin using your policy to build savings. Insurers typically only allow policyholders to convert term life policies before age 65.

Renewability:

You can extend the policy for additional terms, regardless of your health and without having to pass a medical exam. This can be another advantage of term life coverage as you age or if you become ill. Even if you no longer meet an insurer’s underwriting criteria, the company still must renew. Terms can renew at 20, 10, or five years, or even annually. Premiums generally increase at each renewal term. Annually renewable premiums can be extremely high for policyholders past middle age. If you’re paying high annually renewable premiums, you may want to convert to some other type of coverage.

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Texas Cash Value Life Insurance

Cash value life policies provide both a death benefit and a way to accumulate funds over time. However, the primary purpose of cash value coverage is to provide permanent life insurance protection, not to serve as a retirement or savings plan.

Initial premiums for cash value insurance are typically higher than for term life insurance because you’re also purchasing the savings feature. However, cash value premiums generally increase at a slower rate. If you buy a cash value policy at a young age and continue the policy into middle age, your premium will likely be lower than they would for a term life policy with a comparable death benefit.

A portion of each cash value premium is placed into an account that accumulates over time. This is the policy’s “cash value.” The amount may grow at a fixed interest rate, be tied to indexed interest rates, or increase according to the performance of stocks, bonds, or other securities in which the account is invested, depending on the policy type.

A policy may allow you to withdraw from the cash value, use it as collateral for a loan, or use it to make future premium payments, depending on the terms. Withdrawing all of the cash value cancels the policy and ends coverage, however.

When you die, beneficiaries may receive only the policy’s stated death benefit or the benefit plus any remaining cash value, depending on the policy terms. Premiums will be higher for the second option.

It typically takes at least three to five years for a policy to build significant cash value. Moreover, if you withdraw some or all of the money before a specified time period, you will likely incur a substantial “surrender charge,” which can be as high as 10 percent or more. You may also be liable for income taxes on the money. If you purchase a cash value policy, try to keep it for at least 15 to 20 years. About half of the people who purchase these policies cash them in within five years, which is often a financial mistake.

Cash value life insurance can be a good option for people with financial discipline.

The two most common variations of cash value insurance are:

Texas Whole life insurance

Whole life insurance remains in force for the duration of the insured’s lifetime or until the policy is cashed in, provided that the premium is paid. You never have to renew. Premiums either remain constant or increase at a scheduled rate. Part of each premium goes to pay for the death benefit, part to pay the insurer’s overhead costs and profit, and part to increase the cash value. Some whole life policies are “participating,” meaning they may also pay a dividend depending on the performance of the cash value investment account. Typically you will have the choice of receiving the dividend in cash, adding it to your policy’s cash value to purchase additional death benefits, or using it to pay future premiums.

Dividends are not guaranteed. Some policies fail to pay dividends at the insurer’s projected rate, while others may exceed the projection. Your agent may present you with a detailed chart called an “illustration” that shows a policy’s projected earnings. Ask for the company’s history of dividends projected versus dividends actually paid. The agent shouldn’t object.

Texas flexible premium universal life insurance

The key feature to this type of policy is flexibility. Within certain limits, a flexible premium universal policy will allow you to choose the amount of coverage, the premium you pay, and the cash value you build. As long as the premiums continue to be paid and the monthly deductions don’t deplete the cash value, the policy will remain in force until the “maturity date,” at which point coverage ends and the cash value is paid to the policyholder.

Some flexible premium policies pay a guaranteed rate of return. Others are “variable universal life” policies whose value depends on the performance of stocks, bonds, or other investments. For this reason, agents and brokers who sell variable life insurance in Texas are required to maintain a federal securities license in addition to the standard state insurance license. The precise rules and policy terms for flexible premium policies can be complex. It is a good idea to consult a financial or estate planning adviser to ensure you fully understand the policy details before purchase.

A flexible premium policy will allow you to adjust the amount you pay in premium, the death benefit, or the cash value at any time. Any adjustment you make will impact one or both of the other areas: Increasing your premium will build either your cash value, death benefit, or both.

Many flexible premium policies will even provide the option of lowering your premium payments below the amount needed to pay the insurer’s overhead expenses. The company will then deduct that amount from your cash value. But be careful with this option. If the cash value reaches zero, you will have to resume paying the full amount of the premium out of pocket or the policy will lapse. The contract will state that the insurer is required to send you an annual report of the state of your cash value and also notify you if at any point you’re in danger of losing your policy because of insufficient cash value.

Most flexible premium policies contain a provision for a “secondary guarantee,” or a no-lapse premium benefit. A “primary guarantee” is the payment of the premium necessary to cover the monthly deduction. If the primary guarantee isn’t satisfied, a secondary guarantee may keep the policy from lapsing. The secondary guarantee provides a benefit whereby payment of a premium that would not be large enough to pay for the monthly deduction satisfies the no-lapse condition and keeps the policy in force.

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Financial Implications of Owning Life Insurance

Medicaid

The cash value of a life insurance policy is generally considered to be an asset when determining Medicaid eligibility. Some or all of the proceeds from a loan using the policy as collateral might not be considered an asset under certain circumstances, however. If you’re on Medicaid, you may want to consult an attorney or financial adviser to fully understand any consequences of owning a life insurance policy.

Taxes

The cash value of a life insurance policy generally accumulates tax deferred. Withdrawals from the cash value are generally nontaxable until the withdrawal amount exceeds the total amount of premiums paid into the policy.

If a policy has a named individual as the beneficiary, the law generally considers the death benefit to be reimbursement for the person’s loss, and not income. For this reason, the death benefit is typically exempt from the federal income taxes and inheritance taxes that otherwise apply to the insured’s estate. However, if a policy does not have a named beneficiary, or the beneficiary is deceased, the death benefit is paid to the insured’s estate. Heirs to the estate will then have to pay full taxes on the money. If you are considering purchasing life insurance as an estate planning vehicle, you may wish to consult an attorney or financial adviser to fully understand the tax consequences.

Bankruptcy

The cash value and death benefit of a life insurance policy are fully exempt from creditors, all demands in any bankruptcy proceeding, and from execution, attachment, garnishment, or other legal processes unless a statutory exemption, such as fraud, is applicable.

Replacing Your Policy with a New One

Price competition and the development of new types of policies can make it a good idea to review the price and coverage of your policy periodically. However, replacing an old insurance policy with a new one is not always a good idea. Consider the following:

  • New policies usually take longer to build cash values and to pay dividends.
    The two-year contestable period begins again under the new policy. During this period, if you die and the insurer discovers a material misrepresentation on your policy application, the death benefit will go unpaid.
  • If changing to a new policy means withdrawing early from a cash value policy, you could pay substantial surrender fees. Also, the withdrawal counts as income for tax purposes.
  • The new policy may not provide the same benefits and coverages as the old one, causing you to become underinsured.
  • You will probably have to answer additional health questions or have another medical exam.


State law requires agents to give life insurance policyholders a consumer notice with advice regarding discontinuing or changing an existing policy. The notice urges consumers to carefully consider whether a replacement is in their best interest.

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(For more info please visit the Texas Department of Insurance)

 

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