Major Types of Life Insurance
If insurance terms leave you dazed and confused, here’s a quick t for four major types of policies. Keep in mind that definitions may vary slightly from company to company and from state to state:
- Term insurance – The simplest form of insurance. You purchase coverage for a specific price for a specified period. If you die during that time, your beneficiary receives the value of the policy. There is no investment component.
- Whole life – Similar to term, but you purchase the policy to cover your “whole life” not just a set period. Premiums remain level throughout the life of the policy, and the company invests at least a portion of your premiums. Some firms share investment proceeds with policyholders in the form of a dividend. Many companies will offer “a relatively low guaranteed rate of return,” but in reality pay at a rate in excess of the guarantee.
- Universal life – You decide how much you want to put in over and above a minimum premium. The company chooses the investment vehicle, which is generally restricted to bonds and mortgages. The investment and the returns go into a cash-value account, which you can use against premiums or allow to build. With some policies, sometimes called Type I or Type A, the cash account goes toward the face value of the policy on the death of the policyholder. With a second variety, sometimes called Type II or Type B, the beneficiary receives the face value of the policy plus all or most of the cash account. While Type II is meant to provide a partial hedge against inflation, it demands higher premiums as you get older than Type I.
- Variable life – With a variable policy, there is usually a wider selection of investment products, including stock funds. As with a universal policy, returns on investments can offset the cost of premiums or build in the account. And depending on the type of policy, the beneficiaries will either receive the face value of the policy or the face value plus all or part of the cash account.
Advantages & Disadvantages of Life Insurance
Both cash value life and term life insurance has their benefits. The most significant benefit of cash value life insurance is its ability to offer coverage for the entire life of the policyholder. Many people take advantage of buying this type of insurance when they are young when they need it most. Cash value accounts may also be borrowed against or drawn from during the life of the policy. Policyholders are also not required to pay taxes on any interest or earnings attached to cash value accounts.
Individuals and corporations also benefit from term life insurance. The biggest advantage of term life is the often very cheap premiums, especially when a person is young and healthy. It is possible, in many situations, to purchase significantly large face value amounts for monthly costs of $20 to $30. Term life is good for covering financial obligations that will eventually end, such as mortgages, automobile loans and education costs.
With the benefits of both cash value and term life insurance comes a few disadvantages. The most significant disadvantage of cash value life insurance is the inconsistency in premiums. Most cash value policies contain required premiums that can increase over time. This can make the policy quite expensive for people on a budget who wish to purchase enough coverage to benefit their family in the event of their death.
Although many policies contain riders in which dividends from cash accounts can be used to pay premiums, such an instance almost always results in taking funds away from the cash value or investment account. There is also never a guarantee that sufficient funds will be available to cover missed premiums in the event a policyholder falls short.
There are also several disadvantages of term insurance, the first being that it is not permanent. Although a policyholder may enjoy extremely cheap premiums when he or she is young, term products expire after a certain number of years, or when the insured reaches a certain age. When a policy expires, a new one must be purchased. This means that a person must qualify for a new program based on his or her current age and health in order for coverage to continue. Many times, this results in much higher premiums or insurability. Some term insurance does, however, contain “re-up” or “renewal” options that may not require proof that the customer is insurable to continue coverage.
When you think of life insurance, you think of a death benefit being paid to a beneficiary upon the death of a policyholder. Although this is true, it is important to know that with some insurance, especially many cash value policies, it’s often not that simple.
With many cash value life policies, only a single payout is made upon a policyholder’s death, regardless of what the cash value account is worth when he dies. For example, if an individual owns a whole life policy with a death benefit of $100,000 and a cash value account worth $25,000, it is common for beneficiaries to expect a payout of $125,000. This is commonly not the case. In this example, a beneficiary would commonly only receive a total of $100,000. Because the cash value account is worth $25,000, the insurance company would only pay $75,000 as a death benefit, with the other $25,000 coming from the cash value account.
With some products, however, beneficiaries are, in fact, entitled to receive death benefits in addition to cash value accounts when their loved one dies. However, usually an amount equal to the policy’s face value is paid upon death. It is important to know this information before purchasing cash value life insurance.
It is recommended that you consult with an experienced insurance agent before buying life insurance. It is important to find a life product that is tailored to the specific needs of the individual policyholder and his or her family.
Consider whether using life insurance policies as investment vehicles is a wise move for you. Long term, it may be more profitable to buy term insurance and take advantage of low premiums, and then invest in mutual funds or stocks that are not attached to insurance policies.
Tips for buying life insurance
Honestly, how often do you hear about rates dropping for anything these days? The following tips can help you secure good coverage without spending too much.
- 1. Figure out your needs. You can use online calculators to get a rough idea of how much money it would take to cover your surviving spouse’s expenses until retirement, and/or your children’s expenses until they reach adulthood or finish college.
- 2. Opt for term life. A term-life policy is the best and simplest option for most Americans ranging in age from about 20 to about 50. Cash-value life insurance can make sense for wealthy people over the age of 60 – but for most people, term insurance is the way to go.
- 3. Get quotes online.
- 4. Get in shape. To improve your risk class, you can take steps such as quitting smoking, losing weight and reducing your cholesterol and blood pressure if they’re high. You also can get that exam before you apply for insurance so you’re not hit with any surprises.
- 5. Decide how to buy. You can go alone and buy insurance directly from the company, seek guidance from a fee-only financial planner, buy it through a commission-based financial planner, or buy it through an insurance agent.
- 6. Understand how these folks get paid. Insurance agents and commission-only financial planners don’t make money unless they sell you insurance products. Fee-plus-commission planners charge both a fee and a commission on products. Fee-only planners charge a fee for their guidance but don’t sell products; you would buy the insurance coverage on your own.
- 7. Do your homework.
- 8. Buy from a financially strong company. The insurance company should have an “A” rating or higher from rating agencies such as A.M. Best, Standard & Poor’s, Duff & Phelps, Weiss, Moody’s and Fitch Ratings.
- 9. Be alert for red flags. Avoid advisers who say they’re more knowledgeable about the insurance company than the rating agencies, or who claim the ratings are unimportant or unavailable. If you have a complaint, contact the adviser’s customer service department and speak up.
- 10. Make adjustments as needed. Your life insurance needs will change over the years – most notably when you marry, divorce, have a child or start caring for an aging parent. At a certain point – once your kids are all grown up and once you know you’ve saved enough for retirement – you can decide to stop paying for life insurance entirely.