One of the first considerations in your pursuit of the right policy is understanding the various types and how each relates to your situation.
Life insurance policies fall under two broad categories: term and permanent. With a term policy, you purchase a death benefit amount and determine how long you want to hold the policy; it pays out a death benefit if the owner passes away during the specified term. Permanent insurance policies, in addition to providing a death benefit, features a cash value account that builds up a balance over time that you can access.
While a term life policy offers a death benefit only during the selected term, a permanent life policy provides a death benefit that covers your entire life, as long as you keep paying the premiums. Neither term nor permanent life insurance death proceeds are subject to the beneficiary’s income tax, but they may be subject to federal estate taxes.
It’s worth mentioning that older life policies, generally prior to 2001, may actually mature when the policy owner turns 100 and will pay out the face value of the policy, which is taxable to the extent it exceeds the sum of after-tax premiums paid into the policy, while he or she is still alive. Newer policies, generally after 2001, extend to a maximum age of 121.(1)
“What type of life insurance is best for you depends on a variety of factors, including how long you want the policy to last and how much you want to pay.”(2)
Term insurance is a temporary policy, generally sold in durations of 5, 10, 15, 20, 25 or 30 years. Once the period ends, premiums end as well as the death benefit.
Term life insurance is suitable for most people looking to help provide financial protection to loved ones should they pass away. As a general rule, it is easier to understand and tends to be a less expensive form of life insurance. However, it’s important to point out that you can outlive your policy. If you still need to provide financial protection after the term expires, you’ll need to purchase a new policy. Since premiums are based on age, health and competitive rates at the time, it’s very likely you will pay more for a new policy purchased later.
Term life insurance is sold by what’s called the “face value,” which is how much the policy will pay out upon your death. Policies can vary dramatically in face value coverage, from less than $50,000 into the millions.
“Level premium” term life insurance policies offer fixed payments, meaning you’ll pay the same premium amount throughout the term. The premium will not increase. You may have the option to renew or extend the policy term, but the premium amount is no longer locked in at that point.(3)
Permanent insurance remains in force until the policy owner either dies, cancels the policy or allows it to lapse by no longer paying premiums. Since this type of policy is designed for a longer time horizon and potential cash value accumulation, this type of policy generally costs more than a term policy.
Know that there are several types of permanent life insurance. Below is a brief synopsis of each type and the benefits provided.
Whole Life Insurance
Whole Life insurance (WL) provides permanent coverage that is guaranteed to remain in force for the policy owner’s lifetime, provided premiums are paid, or to the maturity date. Premium payments are fixed, based on the policy owner’s age at issuance, and usually do not increase with age. In addition to providing a death benefit, whole life policies build cash value that grows on a tax-deferred basis and can be accessed during your lifetime. Policy loans accrue interest, and policy loans may reduce the available cash value and death benefit.
Universal Life Insurance
Universal life insurance (UL) is a form of permanent coverage with more flexibility than regular whole life. The policy owner can choose to increase (or reduce) the death benefit and even the amount and frequency of premium payments, subject to policy limits. A portion of the premium is allocated for tax-deferred growth and credited to the policy as cash value. You can use this accumulated cash value to pay premiums or to take out a loan. With this type of policy, it is important to make sure the policy is funded correctly and to review your annual statements to make sure the product is performing as intended; if not, evaluate your options with your financial professional.
Variable Life Insurance
Variable life insurance (VL) is a permanent life insurance policy with an investment component that features premium payment flexibility. The cash value portion of the premium payment can be invested in a range of options (e.g., fixed-income investments, stocks, mutual funds, bonds, money market funds, etc.). The cash value and death benefit can fluctuate based on performance of the investment portfolio. Some policies offer a guaranteed death benefit, which will not fall below a minimum amount, for an additional premium. Similar to other permanent life insurance policies, your accumulated cash value grows on a tax-deferred basis and can be borrowed against, however there may be some restrictions due to market volatility.
Variable Universal Life Insurance
Variable universal life insurance (VUL) combines the premium payment and death benefit flexibility of universal life with the cash account investment growth options of variable life.(4)
Indexed Universal Life Insurance
An indexed universal life insurance (IUL) policy is a permanent life insurance policy that features a cash value account, which is linked to a stock market index like the Standard & Poor’s 500. The cash account grows in step with the market index and accrues a portion of its gains, without the risk of loss of premium due to market downturns or fluctuation. If the linked index declines in any given year, the cash value does not drop. In some policies, the insurer offers a low guaranteed interest rate to ensure there is always some growth.
An IUL offers the potential for the cash value to grow significantly over time. The policy owner can access the cash for his or her own needs and even use it to cover premiums.
This type of policy features significant flexibility, as the cash value enables the owner to reduce or even skip a premium payment. Some policies allow the owner to adjust the death benefit, as well, when family needs change.(5)
Both term and permanent life insurance options have their advantages, and depending on your situation you may benefit from one or the other.
If you’re looking to minimize your spending and cover yourself when you need it most, a term insurance policy could be a good option. This tends to be a better option for younger people who may not want to be locked in to premium payments for 60 or 70 years.
On the other hand, if you’re looking to make a long-term investment and guarantee that your beneficiaries will receive a legacy after you die, a permanent insurance policy might make more sense.
1 Michael Kitces. Nerd’s Eye View. March 2, 2016. “The Age-100 Tax Problem With Outliving the End of Life Insurance Mortality Tables.” https://www.kitces.com/blog/outliving-the-end-of-life-insurance-mortality-tables- the-age-100-tax-problem-when-life-insurance-expires/. Accessed July 19, 2018.
2 NerdWallet.com. Oct. 3, 2017. “Types of Life Insurance.” https://www.nerdwallet.com/blog/insurance/types- of-life-insurance/. Accessed June 26, 2018.
4 Pooja Dave. Investopedia. April 25, 2018. “Life Insurance: Variable Vs. Variable Universal.” https://www.investopedia.com/articles/pf/07/variable_universal.asp. Accessed June 28, 2018.
5 Stephanie Powers. Investopedia. Dec. 21, 2017. “Indexed Universal Life Insurance.” https://www.investopedia.com/articles/insurance/09/indexed-universal-life-insurance.asp. Accessed June 28, 2018. 6 NerdWallet.com. Oct. 3, 2017. “Types of Life Insurance.” https://www.nerdwallet.com/blog/insurance/types- of-life-insurance/. Accessed June 26, 2018.
Life insurance policies are contracts between your client and an insurance company. Life insurance product guarantees rely on the financial strength and claims-paying ability of the issuing insurer. Life insurance policies are not FDIC Insured. Index universal life products are not an investment in the “market” or in the applicable index and are subject to all policy fees and charges normally associated with most universal life insurance. Life insurance riders may be available for an additional annual fee; riders may not be available in all states.
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No investment strategy can guarantee a profit or protect against loss in periods of declining values. Guarantees and protections provided by insurance products including life insurance are backed by the financial strength and claims-paying ability of the issuing insurer.
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