Protecting your assets with insurance is often the best way to manage the biggest risks we face. Life insurance planning includes making sure that you are protected with the right type of policy, the right amount of insurance coverage, and that you’re not paying too much for it.
There are many different types of life insurance available today. Life insurance products can be separated into two major categories: 1. Cash value or permanent insurance. 2. Term or temporary insurance. Here is a brief review of the two categories and the most of the common forms of life insurance products within them:
Cash Value/Permanent Insurance
Whole Life – Whole life is the first type of cash value life insurance that most people probably think of when they think about life insurance. Whole life death benefits, premiums and cash surrender values are typically fixed when you buy the policy, and cannot be changed later. This means that your premiums will never change, your death benefit is fixed as long as you continue to pay your premiums, and it will build up cash value inside the policy. Many whole life policies pay dividends on the cash value, and these are generally non-taxable to the policy owner at the time they are paid (in a participating policy). These policies can be set up to have premiums paid every year until you die, or only for a set number of years, or even just one time up front. Loans can be taken from the cash value by the policy owner.
Universal Life – Universal life (UL) has a fixed cost of insurance and any premiums paid into the policy over and above the cost of insurance is credited to the cash value. The cash value that builds up inside the policy earns interest each month, which is tax-deferred to the policy owner. Loans can be taken from the cash value by the policy owner. These policies can be designed with either a fixed death benefit, or an increasing death benefit.
Variable Universal Life– Variable universal life (VUL) is very similar to universal life, except that the cash value can be allocated to a variety of sub-accounts similar to mutual funds. This gives the policy owner the potential to participate in market returns, but also presents additional risk. Some VUL policies can be linked to a market index and have protection from downside losses, as well as limits on upside gains. These policies also allow for loans to be taken from the cash value.
Final Expense – Final Expense life insurance, also called burial insurance, is usually a kind of whole life insurance policy. Some of the differences with final expense insurance is that the policies usually have small face amounts, ranging from $5,000 – $30,000. They also generally have simplified underwriting requirements, meaning you don’t have to take a medical exam or a blood test. These policies can build up cash value but they are usually designed to keep premiums as low as possible.
Term Life Insurance– Term life is temporary insurance that will last for a limited number of years, chosen by the policy owner. Typically term insurance will last for 5, 10, 15, 20, or 30 years. The longer the term is, the more expensive the insurance premiums will be. Term insurance does not build up any cash value, it just offers pure protection from an early death. Most often term insurance is used by younger people who have more bills and obligations than they do money. Term insurance is a great way to protect a young family with children as it would offer a way to pay off the mortgage, fund college expenses, and provide an income stream for the surviving spouse. The reality is, most term policies never pay off because people outlive the term (that’s a good thing!)
Mortgage Protection Insurance – Mortgage protection is a type of term insurance, also known as decreasing term. The policy is structured to cover the mortgage balance owed by the policy owner. The death benefit of the policy gradually decreases over time as the mortgage balance decreases over time. These policies will usually provide enough death benefit to pay off the mortgage, but not much else. If you compare the cost of mortgage protection insurance sufficient to pay off a $200,000 mortgage with a 30 year term policy for $200,000, the regular 20-year term is probably less expensive. If the insured dies with only 5 years left on his mortgage, the 20-year term policy will pay out $200,000 while the mortgage protection insurance would only pay off the remaining mortgage balance.