Life insurance is a fundamental part of financial planning for most families. However, some families, especially in a difficult economy, put off the buying decision. Tight budgets, fear of taking the medical exam, the feeling of invincibility that comes with being young, or the lack of understanding about life insurance and the fear of one’s own mortality can all get in the way of making a wise financial decision to protect one’s family by purchasing life insurance.
Life insurance comes in many flavors, and there is a policy to fit nearly everyone’s budget. Buying life insurance while young offers the cheapest rates; the medical exam is typically no worse than a routine physical, and knowing that the family will not fall into financial ruin if the breadwinner should die can relieve families of a large degree of worry over their financial future.
Term Life Insurance
Term life insurance is the product most people look to for the lowest rates; it provides temporary coverage while a family has a mortgage, education or other expenses to pay off. While it is no-frills, a term life policy does provide the maximum death benefit for a minimum of cost.
Term life insurance has features that apply to most term policies. For example, convertibility is usually offered into an individual whole life, individual universal or annually renewable term policy. Term life is also available with a decreasing death benefit over time. Premiums stay level each year, although the face value reduces accordingly. Term insurance is useful for people who start out with large amounts of mortgage or other debt, and pay it off over the course of the term life policy, with little to no coverage needs towards the end of the term period.
Some other benefits of Term life insurance include is renewable feature where, regardless of the initial term of the policy, the policyholder can extend the term of coverage, although premiums may increase. A rider facility is also available where policyholders have the option of adding a rider facility. This comes with an additional premium charge, and serves to convert term insurance into a whole life insurance policy in the event of the policyholder’s death, to provide ongoing protection for the remaining spouse and children.
Permanent Life Insurance
Permanent life insurance is a type of coverage that provides insurance for the life of the policyholder with a payout guaranteed upon the death of the insured. These types of insurance also accrue cash value, and the permanent life insurance category generally covers most types of life insurance other than term insurance. Permanent life insurance products include whole life, universal life, variable life and combination life.
With whole life insurance, sometimes called ordinary life insurance, the cash value grows in fixed-income investments on a tax-deferred basis. This is the most common life insurance product, and as long as premiums are paid, the policy stays in force. The policy pays an annual dividend, which may vary based on the company’s performance and mortality statistics for the year.
Universal or adjustable life insurance provides flexibility, allowing individuals to adjust policy premiums and the death benefit when changes in estate tax laws, a financial situation or any other circumstance trigger a need. Interest payments on the cash value vary based on the insurer’s business performance and will not go below the published minimum rate.
With variable life, the cash value and death benefits grow and fluctuate based on investments in mutual fund-type investments, which provide a variable rate of return, although there is no guarantee of a return on the cash value. Sub-accounts are created which simulate mutual funds, giving dozens of investment options to allow the policy’s cash value to grow. As with other permanent life policies, the annual growth of the cash value is not subject to taxes.
Some insurers offer a combination life insurance policy, which puts whole life and term insurance together. This allows the policyholder to have a basic whole life policy, with additional term insurance to increase the death benefit for a set period of time, while keeping premiums lower, and allowing the individual to build some cash value in a whole life policy.
Which type of Life Insurance is better?
All types of life insurance have different advantages and disadvantages and your particular financial situation long term goals and lifestyle all play a role in determining which type of life insurance is right for you. Some of the pros and cons of the most popular types of life insurance include:
Pros and Cons of Term Life Insurance
Consider the pros of term life insurance. When an individual only needs life insurance for a certain period, paying for the limited coverage of term life is ideal. Usually, term life is used to protect against losing the income of a household provider in the event of a premature death, which would leave the family in a difficult financial position. In many cases, this risk only exists until the children are self-sufficient and the parents retire. Term life does not carry any additional charges or extra features, which allows the policyholder to get the largest death benefit for each dollar invested in the policy. Term life insurance has very low upfront premiums, which work well for those looking for temporary insurance coverage only.
One of the cons of term life insurance is that individuals have a difficult time knowing how long they will need it. A person could plan on carrying the insurance for 20 years, only to find he needs more years of insurance coverage later. Couples who have a child after buying term insurance, may not have planned to be paying college tuition in their 60s; this would require more tem insurance, and the costs would be the same or more than permanent insurance for his age group. Additionally, if a policyholder has a term life policy that expires or has a non-guaranteed renewal, and has developed health problems, his insurance premiums can increase dramatically.
Pros and Cons of Whole Life Insurance
There are several pros to consider when considering the purchase of permanent life insurance. In most cases, the premiums are fixed which gives the insured a certain level of predictability financially. As long as the policy premiums are kept up-to-date, the death benefit is guaranteed to pay out to beneficiaries regardless of when the insured dies. A whole life policy may build cash value on a tax-deferred basis, and if the policy is surrendered at any point, any cash value is returned to the policyholder. If the policyholder stops making payments, he can either take the cash value as is, or use it to buy a paid up insurance policy or extended term insurance coverage. The insurance company must make at least one of the other insurance options available for him.
Whole life insurance is not without its disadvantages however. The product is more complex and harder to understand than term life insurance. It also has higher premiums than term life in earlier years, and if coverage lapses early, it could become costly due to costs and fees that do not get refunded to the customer.
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