Life Insurance Basics
The main reason for life insurance is to provide income replacement to your beneficiaries if you die. But if you are interested in estate planning, cash accumulation, wealth transfer, and estate tax liquidity, life insurance can also help you achieve these goals.
Put simply, term life insurance provides death-benefit protection for a specified period of time (for instance, you might buy a policy that has to be renewed in two years). Generally speaking, if you’re looking for coverage for a short period of time, term life makes more sense.
But if you are looking to have a policy for the rest of your life, or have investment goals, permanent insurance is a better fit. All life insurance policies will require that you meet certain medical criteria.
Term Life Insurance
Non-Guaranteed Term Life
Non-Guaranteed term life provides coverage only for a short time (usually a year) and is pure death-benefit protection. The risk with term life is that your health might deteriorate and you could be unable to get another policy once the term is up. Premiums can also increase dramatically as you age, but term life insurance is usually a good choice for young people who can’t afford the higher expense of permanent insurance, or for people covering specific needs that will disappear in time, such as a car loan or a mortgage.
Yearly Renewable and Convertible Term
Yearly renewable term insurance offers a longer term, usually for five, 10, or 20 years. By buying a longer term policy, your costs can be stretched out to avoid the annual increases found in non-guaranteed term life.
Convertible term is like yearly renewable term but it also offers conversion to a permanent policy in the future — when regular term premiums might become cost-prohibitive or if your health declines. Convertible term policies usually provide the maximum protection with the smallest amount of cash outlay required. This is a good choice especially for young people who are unable to afford the higher cost of permanent insurance right now but need maximum life insurance and also want to have the option of converting to permanent coverage in the future.
Permanent Life Insurance
Whole Life or Ordinary Life
Similar to yearly renewable term and convertible term, whole life policies stretch the cost of insurance out over a longer period of time in order to level out the otherwise increasing cost of insurance. In this case, however, it is spread not over a few years but over your entire life. Your excess premium dollars are invested in the company’s general portfolio. Because you aren’t personally managing that investment, your selection of an insurance company is vitally important.
With this type of policy, however, the inflexibility of premium payments could become a burden if your expenses increase or if you lose your job.
This option offers greater flexibility than whole or term life. After your initial payment, you can reduce or increase the amount of your death benefit (although to increase the amount, you’ll probably have to give the insurance company medical proof that you are still in good health). Also, after your initial payment, you can pay premiums any time, in almost any amount within the policy’s required minimums and maximums.
You will need to actively manage these policies to maintain sufficient funding, especially because the insurance company can increase charges (like mortality and expenses). Plus, part of your premium is invested by your insurance company, so you’ll need to be careful when choosing a company.
There are both Universal and Whole Life versions of Variable Life. This option provides death benefits and cash values that fluctuate with the performance of the insurance company’s portfolio of investments (you’ll receive a prospectus along with your policy). The cash value is not guaranteed, but you get to choose where your premium dollars go among the variety of investments in the portfolio. Thus, while there is no guaranteed cash value, you have control over your money and can invest it according to your own tolerance for risk. If your investments perform well, you’ll have a higher cash value and death benefit. If they don’t, you’ll have a lower cash value and death benefit, although some policies guarantee a minimum death benefit.
You can also take loans against the cash value of your policy, but if you don’t pay them back with interest, your beneficiaries will receive a reduced death benefit. You can also surrender your policy for cash or convert it into an annuity, but keep in mind that cashing in a permanent policy after only a couple of years is an expensive way to get insurance protection for a short time.
Look closely at the underlying funds a company offers: Are they well-balanced? Do they give you a range of choices to satisfy all risk tolerances?