Ahhhhh…. Life Insurance. So many ways, so many different types. So much.. fuss.
Honestly, every life insurance agent will find a way to solve any problem you have by having you buy life insurance. As always, the more you know, the less likely you are to get ripped off, so lets break it down!
Life Insurance – Insurance you purchase on your life (or someone else’s) that is paid out upon the death of the insured. Theoretically, you would only be purchasing this out of a financial need. So, for example, if you don’t have children, and literally NO ONE will suffer financially if you are gone, you probably don’t need life insurance. Burials may cost too much these days, but a $1 Million whole life policy is NOT necessary to account for a burial & funeral… I promise.
Types of Life Insurance:
- Term Life Insurance
- Life Insurance for a specific time period, or term, ie: 10 years, 20 years, 30 years, etc.
- This is the cheapest type of Life Insurance
- MOST people will only ever NEED a Term policy.
- No bells and whistles, it is literally the simplest type
- Does not build cash value
- Once you stop paying, it goes away and is worth nothing
- Whole Life Insurance
- Life Insurance for your WHOLE LIFE.
- Generally has a pretty high premium since it accounts for the projected cost of insurance when you are 99 years old (which is high).
- Builds cash value
- A portion of your annual premium goes towards paying the cost of insurance/expenses and a portion goes towards cash value. Usually these policies have a minimum guaranteed “rate of return” built into them.
- If you under pay your premiums, you risk that the policy lapses, or blows up, when you are older, and you will have paid in nothing
- IF you have a whole life policy, PLEASE make sure to ask the company through which you purchased it for an in-force illustration. This will show you the projected life span of the policy. Make sure it does not blow up.
- Universal Life Insurance
- Like a term life policy that lasts for your whole life
- Generally more expensive than term life, but cheaper than Whole Life.
- The excess of premium payments above the current cost of insurance is credited to the cash value of the policy. The cash value is credited each month with interest, and the policy is debited each month by a cost of insurance (COI) charge, as well as any other policy charges and fees drawn from the cash value, even if no premium payment is made that month.
- Usually the cash value works on an arch – the value will build up while the insured is young and then dramatically start to tumble as the cost of insurance increases in older ages. The cost of insurance is always increasing.
- These policies need to be constantly evaluated for risk of lapsing. The cost of insurance can be changed at any time by the insurance company and you never want to completely run out of value in the policy.
- Variable Life Insurance
- Variable life insurance is a permanent life insurance policy with an investment component. The policy has a cash value account, which is invested in a number of sub-accounts available in the policy. A sub-account acts similar to a mutual fund – charges expenses/fees, and *hopefully* provides a return
- The investment return and principal value of variable sub-accounts will fluctuate. Your cash value, and perhaps the death benefit will be determined by the performance of the chosen sub-accounts. Variable universal life insurance policies typically include mortality and expense risk charges, administrative fees, and fund expense charges.
- Survivorship Life Insurance
- Insures two people, usually a married couple, and generally benefits their heirs or survivors.
- Is cheaper than other cash value policies because it is based on two lives
- Is cheaper than buying two separate policies
- May help with estate tax burdens.
I’m generally against whole life and universal or variable policies so to make things a bit more fair, here are some benefits of cash value policies:
- You can loan against them
- You don’t have to wait to die to use them – you can create an income stream from the cash value **this would be a taxable event in most policies**.
- You can always increase your own benefit by pouring more into the policy
- You can also decrease your benefit by reducing how much you put into the policy
- Lifelong protection
- Cashflows grow income tax free
- Death Benefits are generally paid to beneficiaries free from income tax
- Provide protection against creditors in many states
- Are not counted in assets for college planning purposes.
All that being said, please speak to a qualified financial planner before making a decision on what life insurance to purchase, don’t let the salesmen.. sell you.