Customizing a Life Insurance Policy With Riders

The longer you live, the greater the chances of disability or illness—especially if certain conditions, like cancer or heart attacks, run in your family. Adding a rider to cover medical care in particular situations can help ensure you don't have to draw upon your estate to pay the costs.

• Long-term care rider: Most adults older than age 65 will need long-term services to assist with health and personal care needs, such as bathing and dressing at some point in their lives. A long-term care rider will help pay for those services by allowing you to tap part of your policy's death benefit, with any remaining funds paid out to your beneficiaries upon your death. Keep in mind that these riders typically have a waiting period before you can start using your benefits, so you shouldn't wait until you need it to add it to your policy.
• Chronic illness rider: Similar to a long-term care rider, chronic illness riders generally cover expenses and medical bills generated by illness or injury that prevent you from meeting a number of your personal care requirements—after any waiting period, of course. This add-on, which some policies offer at no extra cost, also lets you access some of the policy's death benefit during your lifetime. However, the eligibility requirements are much stricter: In addition to the inability to perform activities of daily living, a physician must certify you have a chronic or terminal illness as defined by your policy before you can access benefits.

In both cases, you could hold the life insurance policy in an irrevocable life insurance trust (ILIT)—which is designed to exclude the policy from your taxable estate. If you decide to grant ownership of the policy to an ILIT, just be sure to choose an indemnity rider that makes payments to the trust rather than a reimbursement rider that makes payments to you, the estate owner. Otherwise, the reimbursement payments could be seen as a direct benefit to you, which could nullify the irrevocable nature of the trust and potentially expose the remaining death benefit to estate taxes.

Creating an ILIT can be complex and expensive, and it's difficult to make any changes once it's established. An estate-planning or tax attorney can help you determine if this strategy is right for you.

As your wealth grows, you may want additional life insurance to help make certain the payouts are commensurate with your estate's and heirs' needs. Including particular riders now can help ensure this happens automatically without the need to establish new policies in the future.

• A guaranteed insurability rider allows you to periodically increase a policy's death benefit without submitting to a new medical exam, though you'll likely pay a higher premium to reflect the larger payout. Generally, you can increase coverage only on predetermined dates or at significant milestones, such as marriage, and the amount is often capped each option period.

• A paid-up addition rider gives policyholders the flexibility to occasionally buy extra permanent life insurance, increasing the death benefit and the cash value of the policy without the need to submit to another medical exam. Typically purchased using annual dividends from the policy, these riders are fully paid, so there's no jump in the premium. Be aware adding too much or too soon to the rider may transform your policy into a modified endowment contract, which doesn't have the same preferable tax treatment. Therefore, it's best to speak with a life insurance professional if this rider is something to consider.

  That said, paid-up additions have their own cash value that can grow over time thanks to annual dividends, so the more permanent life insurance you have, the greater the potential for compound growth. But dividends aren't guaranteed since they're based on the financial performance of the insurance company as well as the current economy.

Many people may assume they don't need to plan for estate taxes, given the historically high federal estate tax exemption limits. However, even relatively small estates could face taxes if they reside in one of the states or the District of Columbia that levy an estate tax.

• Estate protection rider: This rider is designed to help offset taxes that may be generated if the death benefit paid by your life insurance policy is included in your taxable estate. If your life insurance policy could grow your estate beyond the current or anticipated exemption, it may be better to place it in an ILIT, which can help remove payouts from your taxable estate. Whether you, another person, or a legal entity should own the life insurance policy should be a decision made with the help of a qualified estate planning attorney.

  That said, for those whose estates are comfortably within the current exemption—but who could face taxes if the exemption changes or their wealth grows—this rider could help plan for taxes without going through the trouble of establishing a trust. Another consideration is estate protection riders are meant to provide temporary coverage and will expire at the end of the specified term. If you outlive the rider, you may lose the death benefit.

Be aware that many riders are available only at the time a policy is established, so it's important to identify your current and potential needs upfront. Even if you don't need certain protections now, it's possible you could require them in the future.

Also consider that, depending on your situation, riders may not be enough to satisfy your particular needs. For example, you could benefit more from a long-term care policy versus a rider attached to a life insurance policy. When in doubt, reach out to your financial advisor or insurance broker to discuss your coverage options. An estate-planning attorney or tax professional can provide guidance on how these riders align with your estate planning strategy as well.