Planning for the future only gets more important as you age. Investments and savings are certainly great to have, but life insurance may supplement long-term planning goals, especially if you’re worried about providing for your loved ones if you are not around.
With life insurance, you sign a contract with your insurer to pay a premium in exchange for a benefit that will be paid out upon your death, terminal or critical illness, or accident (depending on the type of insurance). Premiums may be paid monthly, annually, or in lump sums, again depending on the specific contract.
There are two major forms of life insurance, one of which is broken down into sub groups.
The first type is known as a protection policy and is designed to provide a benefit – typically in the form of a lump sum payment after a specified event, such as a death. A common form of this design is term insurance.
The second type of life insurance is an investment policy where the main goal is to save money in investments through regular or single premiums. Such policies include whole life, universal life and variable life policies. Below is a detailed description of each.
Term Insurance
This type of policy provides life insurance coverage for a specified term in exchange for a specified premium. Unlike investment policies, a term insurance policy does not accumulate cash value. In the insurance industry, term is generally considered “pure” insurance, where the premium buys protection in the event of death and nothing else.
Three key factors to be considered in term insurance are the face amount (protection or death benefit), the premium to be paid (cost to the insured), and the length of coverage (term) which can run anywhere from 1 to 35 years. Various insurance companies sell term insurance with many different combinations of these three terms.
Common types of term insurance include:
- Level: The premiums are fixed for a period longer than a year – up to the entire term.
- Annual Renewable: This is a one-year policy, but the company guarantees that it will renew a policy of equal or lesser amount once the one-year term is up. This type of insurance will have rising premiums based on your age when each one-year term expires.
- Mortgage Insurance: This type of insurance has a level premium, but the face value declines year by year. This can make it cheaper, since the main goal is to pay off the mortgage in case of a homeowner’s death.
Permanent Insurance
This is life insurance that remains in force until the policy pays out, unless the owner fails to pay the premium when due or the policy expires or lapses.
Permanent insurance builds a cash value that reduces the amount at risk to the insurance company and therefore, the insurance expense over time. The owner can access the money in the cash value by withdrawing money, borrowing the cash value, or surrendering the policy and receiving the surrender value.
Permanent life insurance premiums are more expensive than term premiums because some of the money is put into a savings program. The longer the policy has been in existence, the higher the cash value because more money has been paid in. The cash value earns interest, dividends or both.The four basic types of permanent insurance are whole life, universal life, endowment and limited pay.
Whole Life
This provides for a level premium, and a guaranteed long-life insurance protection and death benefit for your family. Such policies accumulate cash values at a guaranteed rate on a tax-deferred basis so that you can use it when alive.
The cash value in your policy can be borrowed against for any purpose and at any time. Unfortunately, the cash values are generally kept by the insurance company at the time of death, and only the death benefit goes to the beneficiaries.
Premiums are much higher than for term insurance, but, in the long run, premiums are roughly equal if policies are kept in force until average life expectancy. The disadvantages of whole life are that premiums are inflexible, and that the policy may not gain as much interest as other investment options.
Universal Life
This is a life insurance product intended to provide permanent insurance coverage with greater flexibility in premium payment and the potential for greater growth of cash values.
Universal life insurance addresses the perceived disadvantages of whole life – namely that premiums and the death benefit are fixed. With universal life, both the premiums and death benefit are flexible by allowing the policy owner to shift money between the insurance and savings components of the policy based on their individual circumstances.
For example, if the savings portion is earning a low return, it can be used instead of external funds to pay the premiums. Unlike whole life insurance, universal life allows the cash value of investments to grow at a variable rate that is adjusted monthly.
Endowments
These are policies in which the cash value that has built up inside the policy equals the death benefit (face amount) at a certain age known as the endowment age. Endowments are considerably more expensive (in terms of annual premiums) than either whole life or universal life because the premium paying period is shortened and the endowment date is earlier. Endowment Insurance is paid out whether the insured lives or dies, after a specific period (e.g. 15 years) or a specific age (e.g. 65).
Limited-pay
This is another type of permanent insurance in which all the premiums are paid over a specified period after which no additional premiums are due to keep the policy in force. Common limited pay periods include 10-year, 20-year, and paid-up at age 65.
Accidental Death
This is a limited life insurance that is designed to cover the insured when they pass away due to an accident including injury, but such policies do not typically cover any deaths resulting from health problems or suicide.
These policies are much less expensive because they only cover accidents. Such policies are often known as accidental death and dismemberment insurance known as an AD&D in which benefits are available not only for accidental death, but also for loss of limbs or bodily functions such as sight and hearing, etc. Such policies are very strict in terms of when a benefit is actually paid so the insured must read the fine print to determine under what circumstances he/she is covered.
It is important to determine what the ultimate goals are of the soon-to-be insured and which life insurance policy will provide the greatest protection at the most affordable price. It is always advisable to consult with a reputable insurance broker before making a final decision. Although life insurance may not be a dinner conversation topic, it is nevertheless one that you should address in your long-term planning.
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