In this episode of Motley Fool Answers, Joe Perna with Motley Fool Wealth Management joins us to talk about life insurance, including who needs it, how much, what kind, possible tax benefits, and more.

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This video was recorded on July 6, 2021.

Alison Southwick: This is Motley Fool Answers. I'm Alison Southwick, and I'm joined as always by Robert Wealthykamp, Personal Finance Expert here at The Motley Fool. I'm trying to make it up to you from last week. In this week's episode, we're joined by Joe Perna, a planner with Motley Fool Wealth Management, to talk about all things life insurance. Do you need it? How much do you need? Where do you get it? All that and more, on this week's episode of Motley Fool Answers.

Robert Brokamp: Alison, please do tell us what's up.

Southwick: Well Bro, we've spent the last year-and-a-half looking for a new hope as COVID continued to strike back again and again.

Brokamp: I heard "a new hope," so I was just doing the Star Wars thing. 

Southwick: Thank you, I appreciate that. Increased wealth, decreased spending, and a world opening up is creating a greatly anticipated sequel; "Episode 6, Return of the Consumer." Actually, it's more like revenge. Bro, cue the music now.

Brokamp: I was going to do the imperial march on that one.

Southwick: Yeah.

Brokamp: There you go.

Southwick: That got dark. In 2019, the savings rate hovered around 7%, 8%. But then COVID hit, and from March 2020 to April 2021, the personal savings rate jumped to 18.7%; the highest rate for such a sustained period since World War II. It peaked in April 2020, at about 33%. Even now while declining, the personal savings rate remains high, about 15% in April and about 12.4% in May. For the last year or so, not only were we not spending as much money; many of us were making more money. The stimulus packages were a big boost to Americans' income whether you were employed or not. But even for those who remain employed, wages and salaries kept growing through the pandemic. Median hourly wages have risen at an average annualized rate of at least 3.3% every month since March 2020. Not just the wealthiest either. People with a high school diploma or less, minorities, women, and people living in rural areas have all seen their hourly median earnings increase at an annualized rate of at least 3% throughout the pandemic. 

What does that translate to in dollars? Well, since the pandemic, Americans have been able to save an estimated $2.5 trillion more than usual, according to the Fed of New York. Because I love talking about the wealth gap in America, I have to mention that the wealthiest 10% of Americans did even better, adding more than eight trillion to their net worth because of stocks and home values that soared. Get your floaties on because The Washington Post says that a spending tsunami is headed our way, largely due to something called revenge spending. It's been a while since I've made that sound in this segment, but there you go. Do you have a ton of disposable income with nowhere to dispose of it and you're also angry that COVID ruined your 2020? Don't fret. Companies hear your cries for revenge and they are going to help you out. As The Washington Post highlighted, companies are seeing the pent-up demand for spending and it provides a great opportunity to raise prices. This isn't just a matter of supply and demand; we're talking about revenge luxury. The Wall Street Journal reported back in January that the highest luxury brands flexed their pricing power and were actually able to raise their prices amid the pandemic. Louis Vuitton raised handbag prices by 6% in May last year, and another 3% this year. Christian Dior raised prices by as much as 11%. Bro, I know that really hurt you personally, the fashionista that you are.

Brokamp: Personally.

Southwick: Yeah, there we go. With puns like that, you know he's fashionable. Even mass market brands are seeing an opportunity to raise prices and dip their toes in the luxury market. We're talking brands like J. Crew, whose highest priced items are 158% more expensive than compared to 2019. Uniqlo, it's like the Japanese IKEA, but for clothes, they are now selling items roughly $100 more than anything they sold in 2019 or 2020 according to the retail research firm, EDITED.

Brokamp: Let me guess. You buy those clothes, you have to take it home, and assemble it? Is that how it's like the IKEA of clothes?

Southwick: Yes, that's exactly what it's like.

Brokamp: Okay, just want to make sure.

Southwick: No, like modern design, they're fast fashion.

Brokamp: You get meatballs along with them. Outstanding.

Southwick: Man, you can get takoyaki. Now, that's a good Japanese meatball, it's octopus. Vacations were a luxury to begin with, but now we're booking revenge vacations and looking to spend even more than before. The Washington Post talked to a travel agent who is booking two $20,000 cabins for a client for a cruise to the Bahamas. She noted that people don't usually spend that much just to go to the Bahamas. Not only that, but the highest-end cabin sold out first and the whole boat was booked in less than 12 hours. We've already talked about the rising cost of real estate in general, so this is just an aside here on revenge real estate. According to Redfin, overall, sales of luxury homes rose 26% in the three months ending in April relative to the same time last year. I don't want to talk about inflation, but the consumer price index rose 5% in May, and the labor department says that's the largest increase since August 2008 when it rose by about 5.4% in one month. But when you look at jewelry, the epitome of a luxury item, prices rose 7.4%. The demand for spending on luxury items isn't just here in the U.S. According to a survey by Ruder Finn, 41% of Chinese consumers said they would increase their spending on luxury goods over the next 12 months. 41%. Now, looking at our two-headed economist over there in the corner, saving money is important on a personal level. Spending money is important for a healthy economy. But on the third hand, if prices rise too high too fast, then that means Alison has to talk about inflation, and I don't want to talk about inflation. It's all exhausting. But you know what's satisfying? Revenge, a dish best served on Wedgwood. So get out there and start spending, wealthy Americans, as if you needed encouragement. That, Bro, is what's up. 

[...]

Brokamp: According to industry trade group, LIMRA, first quarter 2021 life insurance sales were up 11% year over year, and that's the highest level of growth since 1983. A survey found that about a third of participants planned to purchase life insurance in the next 12 months. What's behind this spike in life insurance sales? Well, probably a couple of things. First, the COVID-19 crisis probably increased awareness that we won't live forever. We can't all be Betty White after all. Then just as historically high, government spending and the prospect of future higher tax rates have increased interest in tax-free Roth accounts, so have the income and estate tax benefits of life insurance received renewed interest. Should you also get more life insurance? Is there a better way to manage your current policy? Are the tax benefits of life insurance as good as promised? Well, here to answer those questions and more is Joe Perna, Financial Planner with Motley Fool Wealth Management, a sister company of The Motley Fool. Joe, welcome to Motley Fool Answers.

Joe Perna: Well, thanks so much for having me. Appreciate you asking me to come on.

Brokamp: Back in my financial advisor days, back in the '90s, I had my insurance license, but I think I sold one annuity in my entire career. You on the other hand actually have some insurance experience.

Perna: That's right. I worked as a financial advisor at some of the more major wirehouses. Then I worked for three years at Northwestern Mutual, more as an internal consultant, I'd say. I was helping the reps that went out and actually sold insurance to clients. They would come back to me and ask me to run financial plans, make recommendations based on those clients, the data gathering that they had done, and then provide them with some recommendations. But I really got to understand not just life insurance but disability insurance, long-term care insurance quite well. It was a really nice experience, because when you're working as a financial advisor, you're really focused on the markets and investing. You get to really know the nuances, and you can get creative with some things and see really the different aspects that things might be beneficial or detrimental, depending on the situations.

Brokamp: I think we're very lucky to have you on the show, because I think a lot of life insurance products have a bad reputation as being sold and not bought as they say. But I think there are some underappreciated aspects of life insurance. Let's take a look at six questions that people should ask themselves to determine whether they should get insurance, how much, and what type to get. No. 1 is, do you even need life insurance? Joe, what do you think? What people should consider getting life insurance?

Perna: Life insurance, I would say if I have my Northwestern Mutual hat on or the insurance industry hat on, everybody needs life insurance. From a practical standpoint, I would say if you have a family, if you have children and have a mortgage, those are the three key areas that would prompt me to encourage someone to go out and get life insurance sooner than later.

Brokamp: Yeah. Life insurance replaces either income that someone was earning and then they passed away, but also can pay for services that someone was providing for free. There, we're talking like a stay-at-home spouse or a caregiver relative. The question really to ask, what would happen if I or my spouse passed away? If it would be financially devastating, then you probably should look at life insurance.

Perna: Yeah. When thinking about, like you said, the spousal aspect, the lifestyle shift that might need to be made if your spouse was to unfortunately or untimely pass is a big thing. So if you were relying on their income to do your typical things that you enjoy doing, and you don't want that lifestyle to change upon something happening to your spouse, having that replaced income is really significant if you're in that situation. But to me, the mortgage tends to be a huge cost, same thing with a child entering your life. Those are just milestones that I think you want to protect and you want to have that protection there for your family if something were to happen to you.

Brokamp: There are some estate planning benefits of life insurance but we'll get to those later in the show. Let's get now though into the second question, and that is, let's say you decide you need life insurance, so the next question is, how much should you get? I'm going to give you a common rule of thumb: 10 times your salary, plus $100,000 for every kid you want to put through college. Joe, what do you think of this as a rule of thumb, and what could people do to maybe come up with a more customized number for themselves?

Southwick: I feel like I've been working as a financial advisor and in the financial services industry for about 15 years, and I feel like you can do really customized and detailed cash flow analysis to get to a very mathematical number and, using all these different assumptions, whatever your inputs are, getting to some very specific number that feels right for you. I feel like these rules of thumb are there for a reason, because they tend to be pretty accurate. But really, the way that in the financial or in the insurance industry, what you'll do is look at, again, from a lifestyle standpoint. If your spouse was to pass and you were reliant on their income, you would try to do a replacement of income cash flow needs. You would say, what is the lump sum today if I earn some rate of return on that, like 5% or 6%, what would be the amount that could allow me to replace that person's income for the next 20 years, typically, or maybe until retirement. If you wanted to just calculate this online, you can easily do this, but you would look at replacement of income on top of that if a mortgage was extra to whatever that replacement of an income was, you'd want to add that dollar amount on top. 

Then for children, typically, I don't know of any rule of thumb for things like child care, but in your area, you could certainly look up what child care costs would be if that spouse was providing those child care responsibilities and maybe not the breadwinner for you, and on top of that, college costs if you want to cover that. Those would be the additional factors that would maybe layer in. But again, to me, when I've seen these numbers run, 10 times the salary tends to be pretty darn accurate.

Brokamp: Yeah, I've had the same experience, and I do love calculators as longtime listeners know. You can just Google a life insurance calculator. You'll get some from financial sites, some from insurance companies, and I do think it's worthwhile looking at those, but the rule of thumb is pretty good. Also, I think it's important to know that you probably already have some coverage. First of all, you might be covered by social security. If you pass away, your kids and your spouse may get benefits. I highly recommend that people sign up for My Social Security account and you can see how much your survivors would get and at what ages those will end. You might get some through your employer, which is always good. But generally speaking, it's not enough, and of course, if you leave the employer, you no longer get it. Those are just some places to start to look at in terms of what you already have. Now you decided, OK, I see what I'm going to get. I still need more. 

Now, what kind of insurance should I get? That's question No. 3; what kind should you buy? Really, life insurance comes down to two basic types. One is term, it's just flat-out insurance, it's like homeowner's insurance, health insurance. You pay for it for like a year and you're covered that year, and that's it, it's just insurance. The other type goes by a few different names. Cash value insurance, sometimes it's called permanent insurance, but basically, it's insurance tied in with some wealth accumulation component. It could be a very conservative component that grows like cash bonds. Sometimes, it can grow like the stock market if you're allowed to invest in something like that. We'll just call that as an umbrella term, cash value insurance. Now of course, cash value sounds better. If I can get insurance and get an investment component, why wouldn't I do that? The answer is, it comes down to being pretty darn expensive. I'm going to provide some estimates from a NerdWallet article. NerdWallet actually has a great series of articles on life insurance. Let's say that you are a 30-year-old male in good health, you want a $500,000 life insurance policy. If you get a 20-year term, it's only going to cost you $228 a year. You want a whole life policy, and whole life being a form of cash value, it's going to cost you over $4,000 a year. The older you are, it's going to be even more expensive. Let's say you're a 40-year old female, you want a 20-year term, 500,000 policy, it costs you under $300 a year. Whole life policy, $5,400 a year. For this reason, the standard advice is to choose a term and invest the rest. Just buy the insurance and then invest the difference. Joe, do you think that's generally good advice and why might someone consider getting some form of a cash value policy?

Perna: I'd say, generally, buying terms and investing the difference, the big caveat being you need to be investing that difference into something that's an attractive investment vehicle, whether it's index funds like the S&P 500 or something. It's great in theory to buy term and invest the difference, but most people don't actually invest the difference, and so by doing the "whole life", you're actually committing to a savings program. I think there is some validity there, and so if you are going to be buying term and investing the difference, you want to make sure that investment component is happening. Because really, what the whole life insurance provider is doing is saying you can give us these funds and we're going to invest those funds on your behalf and give you some dividend, then give you a rate of return in the policy for our own investing prowess. Whereas, you can take the additional costs of them doing that, do it yourself, but you have to be comfortable with investing. 

Our listeners of Motley Fool and Motley Fool Answers and the different Motley Fool podcasts that are available, people are generally pretty comfortable on the investing side, so I think you can feel comfortable with that strategy. What's interesting is, I would talk to some clients when I was at Northwestern Mutual who had been longtime cash value insurance policyholders. They had witnessed the dot-com bubble bursting, they had witnessed the global financial crisis in 2008 where the market was heavily beaten up, and they would talk about how their life insurance policies, their whole life, their cash value policies were some of the best investments that they had made because they never had to lose sleep about watching their account values go down. That was a big concern to them. We come across some prospective clients at Motley Fool Wealth Management and they'll tell us, I don't want to lose money, but I expect to get 10% a year. The cost to the game, the cost of investing in the market is, you're going to see volatility. You're going to see your account values go down at times, and within cash value, your life insurance, you do have this steady growth pattern associated with it if you're invested for a substantially long period of time. Then as you mentioned before with estate planning, that's another avenue where permanent insurance like cash value or some of the hybrids are impactful and can be really beneficial. But I would say for a majority of folks, buying term and investing the difference is the great place to be.

Brokamp: For the estate planning benefits, you have to have the insurance last as long as you do.

Perna: Exactly.

Brokamp: Well, until you're 90, possibly, whereas with term, it's very difficult to get term insurance beyond age 80 or 85. You have to do cash value on the permanent side. Let's say someone decides to go with term, maybe they're a young family, have a couple of kids. You have the choice of doing an annual renewable term where the premium goes up a little bit every year, or doing a 20 or 30 year-level term. In that situation, the cost over the course of having the policy might be lower, but you're committing to higher upfront premiums. Do you have any sense on which one is best and whether 20-30 year is sufficient?

Perna: Yeah. I think if you keep that long term in mind and you're able to go back to the original purpose of why you bought the insurance and that rationale is still valid, keeping that 20 or 30-year term policy is definitely the most cost-effective route as you said, and from my perspective, depending on your age, how long you intend to be holding that insurance. Again, with a mortgage involved, or with children which are those major milestones that I think people tend to start thinking about insurance and how much and maybe what years there should be, people will be thinking about how long am I going to have that mortgage. If it's a 30-year mortgage, maybe you tie your life insurance to be along those same lines. Obviously, as you're paying down your mortgage, the principal is going down, and so if you start with a $500,000 mortgage, after 30 years or after 25 years, that mortgage is now $50,000 or something along those lines and so you won't need that bulk of insurance. But there's still some replacement of income costs if your kids are just getting to college at that time. 

Again, those are all factors that you want to figure out the timing component and whether or not 20 or 30-year makes sense. Also with things like the FIRE movement taking more of a hold on people who are wanting to retire earlier and maybe saying, hey, instead of 65 being the normal retirement age, maybe it's now 55, doing something like a 20-year term policy would maybe make more sense for someone in that type of situation. It would really just be catered to your needs, and again, what you want to make sure is your going back after maybe 10 years of having the policy, what was our original objective? It was to cover XYZ. Does it still make sense to keep this amount in force or should we maybe reconvene about adjusting something that we need to? That'd be how I'd be thinking through and making that decision, and it can change over time. There are certainly life stages and life circumstances that can warrant making a significant shift to what type of insurance you might have.

Brokamp: I was going to say personally, I have a couple of policies. I bought my first one when my son was born, and because I'm a cheapskate, I just went with the 20 year-level term thinking in 20 years, my son will be in college. Ideally, we'll be fine financially. Well, that 20-year policy is now coming up and I wish I had gone with 25 or 30 years. The thing about if you decide to go with the term insurance, getting an extra term or getting an extra amount, an extra $100,000, $200,000, $300,000 added to the policy, it's not really that expensive. If I could go back in time and do it, I probably would have done it longer than a 20-year term.

Perna: That's a fantastic point, and like you said, adding an additional $100,000 or $200,000 to the policy at the onset, you're not going to even notice the cash flow difference to your monthly payments. Yeah, that's a huge point. Just to circle back on the estate [...] aspect and with term, there are companies out there that when you buy a term insurance policy, let's say you're a small business owner and your business is growing and your estate is actually going to be becoming an issue down the line, you're seeing that becoming a higher probability, there are policies and insurance companies out there that will allow you to convert that term policy into a permanent policy based on your original health characteristics. Rather than waiting or being concerned about him, 15 now, I need to get this insurance at this point based on my current health characteristics. If you've got that insurance of, let's say, a 30-year term, when you are 30 years old, they'll use that original health characteristic for that conversion that you wind up doing, again, if that ends up fitting into your needs. That can be an attractive feature that some policies have.

Brokamp: Yeah, that's a good point. Now, if you decide that you need insurance, get it as soon as possible, because the younger you are, the cheaper it's going to be and the less likely you're going to have any health issue that will then drive up your premiums. Let's move on to the next question. You decided roughly that you need it and how much you should have. The next question is, where can you buy it? These days, it's pretty darn easy to buy term insurance online. I recently read an article about it and I'm just going to provide a few websites that'll provide you easy quotes; AccuQuote, LifeQuotes, Policygenius, Quotacy, and then ValuePenguin. Very easy to just go, enter your information, get a quote based on what you say. Now, some of these, most of them actually will require some follow-up medical examination, but not all of them. Joe, what do you think of people buying life insurance from the Internet and where else should they go if that's not the best option?

Perna: Did you say Lemonade on that? I feel like that's one that you might want to throw in there.

Brokamp: Yeah, Lemonade is a good point and that's a relatively recent entry. That's one that will offer you a policy without the medical examination. You're seeing more and more of that these days.

Perna: Yeah. From my standpoint, I think a lot of those websites that you've provided, those are fantastic places to start and can really help you hone in on what maybe the cheapest policy is. To me, if I'm looking for term and I have the foresight, or if I'm thinking long term and really believe that I'm not going to need any adjustments to that term policy down the line, I think going with a cheap option with a reputable name, those are important because you want the company to be there in 20 years, that if something did happen, they can pay out on that policy. But another thing that I would consider would be if I am bundling, I feel like it's a progressive commercial with that bundle, where they're at the beach and they're talking about, it's a bundle. In my mind, if you have homeowners, if you have a car policy all through the same provider, perhaps they have some discount by also doing some term insurance. That's something I think that you could check out. 

Then, Bro, you had mentioned this earlier. Your employer offers some maybe voluntary additional insurance you could buy, and that is an option and probably a pretty cost-effective option. However, if you will leave that job and move to a new company, if they provide the same type of insurance, that's a question mark, how has your health changed since maybe the initial job, and is that going to affect you being able to get insurance at a new company, or if you're going to be no longer working. I think it'll provide some headaches and I would prefer to see someone who does need insurance to go out and get supplemental insurance outside of the company they work for.

Brokamp: Yeah. I'll point out that these days too, there's some great sites that rate insurers. [...] Investopedia, NerdWallet, and The Balance. Like a lot of sites that rate financial products, there might be some conflicts of interest there. You want to understand how those websites are getting paid, but I think the information is still helpful and part of those reviews will include the insurers' rating. You talked about how you want to make sure you get a highly rated insurance company. You want to make sure that they're around. One rule of thumb there is just choose someone that's rated A or better, but that's just a rough rule of thumb. Let's talk about why someone might go to an insurance professional. One might be, for example, that you have health issues. Tell us about why you should see a professional and maybe who you should see, the difference between a broker and agent, those types of things.

Perna: Yeah, that's a great question. When I think about some of those health issues, that is something where when you speak with someone, a professional who understands the insurance world really well, and again the nuances of the insurance world, it's helpful to have somebody who might know, hey, this company I know does not concern themselves with this type of health issue. They can help you navigate the decision-making so that you're not turned down by an insurance company, because if you have a policy that's rejected, that could look negatively upon you for trying to apply for additional or other life insurance policies. It is important that you have someone, if you do have health issues, navigate around what insurance companies would be beneficial based on those conditions. It is helpful to be honest with the professionals so that they can navigate around which companies might be checking for whatever those issues are. When I think about Colorado, something that comes up is marijuana is legal here. I have a friend who had recently gone and they had a professional who said is this something that we should be concerned about because there are certain companies that are going to check for that. Again, just that nuance will help you with making sure that you're not going to get rated a certain way, and again, that classification could hurt you going forward making applications or requests at other insurance companies. That is one benefit. 

Then additionally, there are a lot of hybrid policies. We talked about term and we talked about permanent and then whole life or cash value life insurance. Generally speaking, those are two big categories and there are a lot of middle ground between them, and depending on what someone is looking for, and I would say in particular more around estate issues, having some nuance is helpful and having someone help navigate the many different policies out there, someone that you can really trust, if you can get referrals to a professional, that tends to be the best way to find out about who is really a prime candidate for your business. I think getting referrals is a great way to start helping you navigate those hybrid policies. 

When I think about estate planning, if you want to do something that you mentioned in your article, the irrevocable life insurance trusts, a lot of those are funded by what are called guaranteed universal life policies that are a little bit different. They're not as expensive as your typical cash value or whole life insurance policy, and so having someone help with navigating what would be the best policy for this specific situation and what's going to be cost-effective and having someone work with you through those items. Additionally, there are some life insurance policies that also have long-term care provisions on them, or maybe chronic illness riders. Those things are also helpful. If you want to not only get life insurance, but also, if you were to have a long-term care event and need to go into an assisted living facility or a nursing home prior to needing that life insurance, a hybrid policy that has both attached could provide some support during that type of issue. Again, having a professional that understands the nuances is extremely helpful in those situations.

Brokamp: Between the two, one rule of thumb is; you have brokers and agents. A broker represents you, whereas the agent represents either a group of companies or a single company. When you understand that, the standard advice often is we'll go with the broker of course, because the broker can look over a span of many providers and choose the best policy for you. Whereas the agent, if you go to, for example, an Allstate agent, they're going to sell you an Allstate policy generally speaking. But given your experience, is it fine to go with an agent or do you think most people should start with a broker?

Perna: Really, almost all my experience has been with the broker side. I think similarly with maybe your mortgages, where if you go to a bank, they only have their 30-year mortgage option. They don't have the ability to scan and look to see what other banks are providing and you're somewhat locked in. I would think the same thing for an agent. I mentioned earlier that if you have your home insurance, your auto insurance, and you want to look to just maybe tack on your life insurance to that policy, there might be some bundled discount there. But outside of that, I would personally be seeking out a broker to be able to, like you said, scan all those different insurance companies and give you the best offers, and really understand your needs and goals and can tailor that recommendation to your specifics. 

Another thing, I always like to say this, I am big on just the misaligned incentives in the financial services industry in general. Just know in the back of your mind that when you are meeting with brokers, at the end of the day, that first year premium that you're paying to the insurance company, that is a direct reflection of their compensation. So understanding that if they are recommending a whole life policy and you don't feel it's right for you, I think the numbers that you've mentioned, if it's $4,000 for that first year, recognize that they're getting paid somewhere close to that. What I have seen in the past is 80-100% of that first year premium goes into their pocket as a commission. So if that term policy only pays them $200 for that year, they're only getting $200 versus that 4,000. That's a huge difference. In the end, most people are good actors and try to help people. I think that's why I got into the industry and why many people get into the industry. But in the end, those incentives are going to drive behavior, and so just be aware that if there is a higher commission product, there is that question mark of, is it really in my best interest? Just make sure that you're asking sometimes difficult questions and making sure that they are looking out for your best interest.

Brokamp: Excellent point. The person who is trying to sell that policy will often emphasize the tax and estate planning benefits, so that's the next big question. What are the tax and estate planning benefits of life insurance?

Perna: The tax benefit that really gets looked at and highlighted by people that tend to focus on selling cash value and permanent policies, whole life policies, are going to be the tax-free growth associated with it. When you put the funds in, part of that premium goes to insurance, but part of it goes into this cash value bucket, and for a whole life policy, the dividend credit policy of that insurer is going to end up adding to that cash value that you're putting, the premium that's going into the cash value portion of things so that you're able to generate a rate of return. Long term, at Northwestern Mutual or the other insurance providers like New York Life or MassMutual, they have certain dividend rates that they've credited and they might have a hundred years of saying, hey, we credit 5.5% dividends. It has been our average dividend payment over a hundred years. Now, does that mean that you're getting a 5.5% rate of return on your cash value? No, because the paying for insurance part of the money is going toward administrative and other expenses. So not all of it is getting credited with that rate, and a lot of times, insurance agents or insurance brokers might skip that part of things and just say, yeah, our five-and-a-half% dividend, but in reality, what all these policies do, if you're looking at a whole life policy and really want to understand the return that you're getting, and again specifically on a whole life policy, you can ask them to run illustrations that show the internal rate of return. What is my cash value actually going to do? What's the rate of return that you're projecting based on the current dividend rate for 30 years or 40 years? 

You can run that so that you at least have an understanding of, OK, this is cash value growth and tax-free growth and tax-deferred growth, tax-free is the main focus here, but what is it that you're actually seeing on the dollars that you're putting into the policy. One issue with the cash that you're building in those policies, you can access it in a tax-free fashion, but it is a loan against the policy. Now, whether or not those loans need to be paid back, at least with Northwestern Mutual and the policies that we tended to see, you did not have to pay those back, but what we do is we just decrease the death benefits. If you had a half $1 million in a death benefit and you had $100,000 that you had taken out tax free, that loan will just be deducted from the death benefit, and if you were to pass away and you had not paid back that loan, your beneficiaries would get $400,000.

Brokamp: Yes. It's important to note too, if you take out a loan and then you surrender the policy, you just stopped paying premiums, and the loan exceeds basically the basis in the policy, you could be taxed on the difference.

Perna: At ordinary income rates, yeah. That's a huge point.

Brokamp: The estate planning benefits, what's your take on those? Is that something most people should consider or is this something just for people who will be beyond the estate tax exemption, which this year is I think $11.7 million per person?

Perna: I would tend to say if you're below that estate planning minimum, I don't see any reason to have that planning need. Now, as you mentioned in your article on [...] retirement, there are expectations that the maximum per person is going to be decreased. it sunsets in 2026, but there also is talks with some of the Biden tax proposals that they could lower that to even a more dramatic amount. Maybe it's down to two million dollars per person. It's impossible to know where they're going to end up going with the legislation in the end, what's going to actually be written down and put into effect. But I think there are some concerns that if you're close to that estate level, even if your estate is starting to grow to the sunsetting number, which I think it was at $6 million, was that right?

Brokamp: Yes. Approximately. It will be adjusted for inflation by the time that year goes around, but yeah, it's about $6 million per person is what they're projecting at this point in 2026.

Perna: If I'm getting close as an individual or for a couple up to $12 million and thinking about your own personal situation, all of this in financial planning comes down to someone's personal situation. But when I talk with clients, a lot of times, we talk about, does it make sense? Do you want your kids? A lot of times, the beneficiaries are the children of the individuals that we're speaking with. Do you want them to have additional funds? If you're leaving them, let's say, $15 million, are you really concerned about that tax they're going to be paying? Sometimes, they say yes, and sometimes, they say they should be happy that they're getting any money in the end. So if they end up getting taxed a bit, it really doesn't matter. But for folks that are concerned around the estate tax that would be levied [...] above that maximum, I think an ILIT, irrevocable life insurance trust, is something that's commonly looked at that can be fairly easily utilized to offset what those taxes will be.

Brokamp: This is a very complicated topic, definitely something you need to talk to a professional about. But I'll just highlight two things. It's important that you don't own the policy, and that's why it's often put into a trust, because if you own the policy, it is included in your estate. Another tax benefit of life insurance, by the way, is that it's income tax-free. If you're the beneficiary of a million-dollar policy, you don't pay taxes on that. That is something also to throw into that whole mix. We just have a few minutes left. Maybe perhaps after you've listened to all of this, you've thought, you know what, I have this cash value policy or this insurance policy, after listening to all this, I don't think I need it anymore. So our final question is, Joe, what can you do with the policy you no longer want?

Perna: I think the highlight in the article, several things I think are important to understand. Surrendering the policy is obviously something that you can do, where basically if you've paid into it for five years, whatever the cash value or the surrender value is, you're accepting that back from the insurance company. A lot of people have trouble. I have talked to people who have said, I've paid into this thing for five years, I might as well just continue to pay into it because I don't want to lose that insurance cost. So if they've put $50,000 into a policy and there's a $20,000 surrender value, they've lost $30,000, and in my mind, it is a sunk cost that we cannot overcome. We have to think about it, in the current moment, is this the best place to put your money if you've decided that this is not a worthwhile policy and I should be doing something else with the premiums and putting it toward another vehicle that might be a better investment? Obviously, just factor in what that future outcome is going to look like or what is the better outcome for you on a go-forward basis. You can't go back and recoup those losses unfortunately, and so you're going to have to just move on and again make the best decision with the current information that you have.

Brokamp: Another possibility is you can exchange it for another insurance product. It's actually called the 1035 exchange. It's a tax-free move and you can use it to buy another policy that you like better, a paid-up policy, or even a whole different type of insurance product like an annuity.

Perna: Yeah, that's a great alternative. You also referenced a long-term care policy as another option. If there was an assisted living facility needed down the line, nursing care, that is another option for that 1035 exchange.

Brokamp: The final word on this I will just say is, it can be very complicated about what to do with an existing policy, so I highly recommend that you talk to an expert. It could be the person who originally sold you the policy, assuming you still trust her or him and you don't feel like that you were taken advantage of, if you have a financial planner, maybe even an accountant if they understand it, because there can be some financial consequences to switching policies, or just to giving up a policy when maybe you could have just exchanged it for a better policy in your situation. Thank you, Joe, for joining us. Any concluding thoughts on helping people think about their life insurance?

Perna: I hate painting things in such a broad brush. I feel like a lot of times, I hear people that just say all permanent insurance is bad. It really does come down to depending on your goals, your needs, objectives. Everyone is different, and there are times where permanent insurance does make a lot of sense. As I mentioned with my little anecdote earlier, we talked to many clients that had long term whole life policies that were very happy with how they had performed, and again, just not having that downside and seeing them as just that consistent growth that they could access in a tax-free fashion. Again, if you understand those policies, they can be beneficial. I don't just like saying that all permanent insurance is bad and it doesn't make any sense to have it. It is nuanced, and talking with someone who really understands the ins and outs is extremely helpful. Try to make sure that they're a CFP, a Certified Financial Planner, and looking out for your best interest is really important.

Brokamp: Excellent points. Again, our guest has been Joe Perna of Motley Fool Wealth Management, a sister company of The Motley Fool. Joe, thanks for joining us on Motley Fool Answers.

Perna: Thanks so much for having me. It's been a pleasure.

Southwick: Oh, that's the show. It's edited vengefully by Rick Engdahl. Our email is answers@fool.com. For Robert Brokamp, I'm Alison Southwick. Stay Foolish, everybody.