Life insurance helps to ensure that your family and loved ones are protected against financial difficulties in the event of a premature death. This section gives you basic information about various types of life insurance.
Term Life Insurance
Term insurance provides protection for a specific period of time. Term insurance only provides a death benefit; there is no cash value in the policy. For this reason, term insurance is very affordable, which is why it’s the most popular life policy sold.
Term life insurance is for temporary needs. These needs could include a mortgage, providing for children or income replacement for a spouse.
Term policies lock your rates in for a specified amount of time, typically 5, 10, 15, 20 or 30 years. At the end of the term, you can usually renew at a higher premium. Many policies require that you present evidence of insurability at renewal to qualify for the lowest rates.
When purchasing a term insurance policy Be aware of non-guaranteed policies. The premium for a 20-year policy might only be guaranteed for the first 5 or 10 years, depending on the company. After the initial guaranteed period, the company has the contractual right to increase premiums to the maximum amount printed in the policy, usually double the current cost. This is known as a “trust me” policy. The company in essence is stating, “We are charging this premium now, and most likely, this will be the premium we will be charging for the entire period. However, if we need to, we reserve the right to increase your premiums after the initial guaranteed period.”
Make sure your agent explains your options to renew the policy.
Make sure your agent has access to different insurance companies. Rates will differ from company to company, so take the time to shop around.
Advantages:
- Very affordable rates
- Ideal for temporary needs
Disadvantages:
- No build up of cash value
- Premiums usually skyrocket after the term period is over
Permanent Insurance
Permanent insurance, also known as cash value insurance, provides a death benefit and a savings/investment benefit. The premium for this type of policy is higher than term insurance because of the cash value in the policy. This type of policy is designed to cover long-term needs, such as to pay estate taxes, to fund a trust, or to cover the cost of a funeral.
The cash value aspect is why most people decide to buy this type of policy. The accumulated value earns interest, dividends and grows tax-deferred as premiums are paid. The cash value of a policy is different from the policy’s face amount. The face amount is the money that will be paid at death or policy maturity. The cash value may be affected by your insurance company’s financial results or experience, which can be influenced by mortality rates, expenses, and investment earnings.
The cash value belongs to the policyholder and may be used in various ways. You can cancel or surrender the policy in total or in part and receive the cash value as a lump sum. If you surrender your policy in the early years, there may be little or no cash value. You usually can borrow from the insurance company, using the cash value in your life insurance as collateral. Unlike loans from most financial institutions, the loan is not dependent on credit checks or other restrictions. You ultimately must repay any loan with interest or your beneficiaries will receive a reduced death benefit.
Here are three types of permanent policies:
Whole Life Insurance
With a whole life policy, your premiums generally remain constant over the life of the policy. Premiums will be mostly determined by your age, so the younger you are when you purchase the policy, the lower your premium will be. The whole life premium is much more than the cost of term life insurance. With whole life, you may pay higher premiums for a fixed number of years, after which, the cash value in the policy should be sufficient enough to pay the premiums.
Universal Life Insurance
Universal life insurance offers you more flexibility than whole life because it allows you to change the premium or the death benefit at any time. Universal life insurance allows you to design your own policy. You may increase or decrease the premium as your financial needs change. You also control the frequency and duration of the payments. The policy will remain in force as long as the cash value is sufficient enough to cover the monthly cost of life insurance. Net premiums (premium – cost of insurance and expenses) are added to the cash value and will grow, tax deferred. The cash value earns interest each month at the current rate. The current rate is based on short-term rates in the money market and therefore is not guaranteed and may change. The policy will have a guaranteed interest rate, usually 3% or 4%.
Variable Life Insurance
With a variable life policy, your premiums are fixed but your death benefit is not. The death benefit will rise and fall based on the performance of a portfolio of investments, but a minimum death benefit is guaranteed. You can allocate cash values that remain after the cost of insurance and policy expenses are paid into a variety of separate accounts, offering different degrees of risk and reward. These separate accounts usually include mutual funds, equities, bonds or money-market accounts. The cash value of your account does not earn a fixed rate of return. The growth of your cash value depends on what investment you choose and the performance of it, therefore, no guaranteed cash value exists and the policyholder bears the risk. You will have the option of shifting your investments around.
When purchasing a permanent policy —
Do not buy a cash value policy as a retirement plan. It’s life insurance – not a retirement plan, even though your cash value grows tax deferred. The cash value may help out in retirement, but won’t perform nearly as well as an IRA or a 401K plan would.
Make sure your agent has a good understanding of the different plans available to you. Your agent should be willing to assess your specific needs. A good agent will guide you to a plan that will suit your individual situation.
Consider taking the time to map out your financial plans for the next 20 years. Then review your life insurance policy options, and choose the one that fits in with your future financial goals.
Advantages:
- Tax-deferred growth of your money
- Tax-favored income
- A policy that can be kept for life with fixed or flexible premiums
- The cash value is a personal asset and is reflected on your balance sheet
- A provision or rider can be added to a policy that gives you the option to purchase additional insurance without taking a medical exam or having to furnish evidence of insurability
Disadvantages:
- Premiums are much higher than term insurance making it difficult to afford sufficient death benefit
- Policies can be confusing
How much life insurance should I have?
The “rule of thumb” suggests an amount of life insurance equal to 7 to 10 times annual earnings. But there are many other factors to take into consideration. Important factors include:
- Income amounts other than salary such as pensions, SSI benefits and the like
- If married, what is your spouse’s earning capabilities?
- Number of individuals who are financially dependent on the insured
- The amount of death benefits payable from Social Security
- The amount of death benefits payable from an employer sponsored plan
- Special needs for payoffs on mortgages, educational funds or taxes
Should my spouse and child have a policy as well?
The most important person to be insurance is the main income provider(s). If your spouse does not work, then calculate expenses that you would incur upon his/her death. Items like funeral expenses, taxes, and other expenses that are not so commonly known, such as household services that would need to be replaced after a family members death, e.g., child care, maid service, care giver, and the like should be considered. You may also opt to purchase life insurance on your children – generally this is to cover funeral expenses or to protect their future insurability.
What type of life insurance policy should I buy?
You should buy term if you only need coverage for a specific period of time (home mortgage, or until your children are financially independent), need a lot of coverage and can’t afford permanent, or don’t want the commitment required from permanent insurance.
You should buy permanent insurance if you want guaranteed life insurance for life and don’t want to risk outliving your term and having nothing to show for it, need the insurance for estate planning purposes, or want a forced savings.
If you are interested in more information, please contact our office.