Life insurance is a vital part of your family's long-term financial plan. Unfortunately, it is the one that everyone wants to discuss the least. Life insurance involves death, which nobody wants to deal with, especially when it is sudden and unexpected. However, the sole purpose of life insurance is to replace your income for your family if you die. There are many choices available and we are here to guide you through the most common policies and find the one you need for your family.
In a previous blog, I explained term life insurance. Term life insurance is simple and usually the most affordable type of life insurance. In short, if you die during the policy term (usually 10, 20, or 30 years), the life insurance company will pay your beneficiaries the death benefit amount specified in the policy. A term policy is worth nothing unless you die during the course of the term. Read more about term life in this blog entry here.
In this blog, I will discuss permanent insurance such as whole life, universal life, and guaranteed universal life.
Permanent Life Insurance
Term life is simple to understand. It does one thing only: pays your beneficiaries at fixed amount of money if you die during the policy term. Permanent life insurance is a bit more complex since it is trying to do two things at once. It provides the benefits of life insurance and trying to be an investment account at the same time.
A permanent life insurance policy includes an account called "cash value". The easiest way to think of this is as a savings account that you are depositing money into every month. It's a pool of money you own and can access or borrow against. The longer you have the policy, the more cash value the policy will accumulate. The premium you pay each month, part of it goes toward paying the premium and part is deposited into the cash value account.
Unlike term insurance, permanent life insurance doesn't expire. As long as you pay the premium, the policy will remain active. With some select policies, you may even be able to skip a premium payment and use money in the cash value account to pay the premium. Permanent life insurance is generally a lot more expensive than term insurance. A $500,000 whole life policy would be 5-10 times more expensive than a $500,000 term life policy. Unless you have significant wealth to be used for estate tax purposes, most people do not need that much permanent insurance. A small $25,000-$50,000 policy is sufficient to be used for burial and final expenses. Ask yourself: why would I need $500,000 of life insurance when I am 80 years old? You don't!
Permanent life insurance policies can include whole life, universal life, guaranteed universal life, and variable universal life.
Whole Life Insurance
This is the safest form of permanent life insurance. When you purchase a whole life insurance policy, you lock in the premium amount for as long as you want the policy - usually age 100 or 121. Each month you pay the premium to the insurance company. The premium is fixed and cannot be changed. A portion of the premium goes into the cash value and grows over the whole life of the policy. The interest rate of growth of the investments in the cash value account is fixed. This interest rate is guaranteed by the insurance company, regardless of how the investments perform in the market. The investments are usually very safe investments. Since the interest rate is guaranteed, the cash value account always increases.
The life insurance company is also guaranteeing the death benefit and the money in the cash value account. The insurance company is taking on a lot of risk when issuing a whole life policy. All that you have to do is pay the premium every month. That is why this type of policy is the most expensive.
Whole life companies also pay out dividends to policyholders. These dividends will grow over time, and can be used to pay the premium or purchase additional life insurance using a paid-up addition rider on the policy. Think of these paid-up additions as mini policies that each receive dividends, which in-turn increase the cash value and death benefit of the policy
Whole life is a great option for parents or even grandparents to purchase for their children and grandchildren. Payments options exist such as 10-pay and 20-pay, which means you only have to pay the premium for 10 years or 20 years, then no other payments are required. These policies can accumulate a significant cash value and death benefit over time.
We generally don't recommend whole life to adults. It is very costly and the extra amount you are paying compared to term life would be better invested in a mutual fund for the long-term. Getting approved for a $500,000 whole life policy is much more difficult than getting approved for a $500,000 term policy. The difference in pricing is huge. Unless you have significant wealth to afford a $500,000 whole life policy, a life insurance company will decline you.
This policy is similar to whole life and has a death benefit and cash value. Unlike whole life, universal life offers adjustable premiums. That means you might be able to access some of the cash value to adjust your annual payment. You still need to pay the minimum premium payment, but you might be able to eliminate a premium payment depending on how much cash value you have. Similar to whole life, part of your premium payment goes towards the death benefit and another part is invested in the cash value savings.
The investments in the cash value account are more risky than the investments in whole life. The insurance company decides where these investments will be placed. The interest rate of growth for the investments is not fixed and depend on market performance. However, the life insurance company might offer a minimum interest rate if your investments perform badly in the market. Since the life insurance company is passing more risk onto you, they are less expensive than whole life.
If you pay the minimum premium, the cash value and death benefit are only guaranteed for a certain number of years. After that time, they are no longer guaranteed. It's important to fully read the policy illustration to see how long these are guaranteed. You do have the option to pay more into the policy to extend the guarantee period.
Guaranteed Universal Life
This type of policy is like an extended term life insurance policy that will cover you for your entire life, usually to age 95, 100 or 121. Unlike a universal life insurance policy, they accumulate little cash value and act solely as pure death benefit protection. These are very popular among clients who only want death benefit protection and no interest in using life insurance as an investment.
Variable Universal Life
Variable universal life is similar to universal life policy, but you have the choice in how the cash value is invested. You can invest in stocks and bonds of various risk levels. Since more of the risk is placed onto you, it is cheaper than whole and universal life. You bear the risks of the investments. Variable universal life offers no guarantees with the cash value. It can increase or even decrease to zero. Management fees with this type of policy are generally hefty, so we do not recommend them anymore to clients. We aren't even licensed to sell these products anymore.
Call us today at (845) 724-3031 or request a life insurance quote via our website!
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