Q: My spouse and I are debating whether we have enough life insurance and also what type we should consider getting if we need more. Can you please help us better understand our options?
A: Finding the middle ground between being “insurance poor” and being unprotected requires assessing real needs and choosing products that are affordable. This article introduces different types of insurance products and the role that they can play in a personal financial plan.
Death is one of things that no one likes to talk about. Yet, protecting loved ones from the financial consequences of death is one step you can take to gain confidence for you and your loved ones. And this is where life insurance enters the picture.
Life insurance may be for you if you have a family or partner/spouse who depend on you for financial support, if you work at home providing your family with such services as child care, cooking, and cleaning, or want to protect a surviving spouse against the possibility of unexpected medical expenses. People with substantial assets may need life insurance to help reduce the effects of estate taxes or to transfer wealth to future generations.
Determining what type of insurance depends on your goals, while deciding on an appropriate amount of coverage requires an assessment of your needs. Some approaches use a formula based on your income, while others factor in future liabilities, such as mortgage debt, college expenses and estate taxes. The bottom line is quite simple: Don’t go it alone. Enlist the services of a qualified life-insurance professional to help determine the type and scope of coverage that best suits your financial objectives.
Conventional wisdom says that life insurance is sold, not purchased. In other words, some people are reluctant to discuss the importance of owning life insurance and others are simply unaware of the need to have life insurance. Although many large companies provide life insurance as part of their benefits package, this coverage may be insufficient.
Types of insurance
Term insurance is the most basic, and generally least expensive, form of life insurance for people under age 50. A term policy is written for a specific period of time, typically 1 to 10 years, and may be renewable at the end of each term. Also, the premiums increase at the end of each term and can become prohibitively expensive for older individuals. A level-term policy locks in the annual premium for periods of up to 30 years. Unlike many other policies, term insurance has no cash value. In this sense, it is “pure” insurance without any investment options. Benefits are paid only if you die during the policy’s term. After the term ends, your coverage expires unless you choose to renew the policy. When buying term insurance, you might look for a policy that is renewable up to age 70 and convertible to permanent insurance without a medical exam.
Declining balance-term insurance, a variation on this theme, is often used as mortgage insurance since it can be written to match the amortization of your mortgage principal. While the premium stays constant over the term, the face value steadily declines. Once the mortgage is paid off, the insurance is no longer needed and the policy expires.
Whole life combines permanent protection with a savings component. As long as you continue to pay the premiums, you are able to lock in coverage at a level premium rate. Part of that premium accrues as cash value. As the policy gains value, you may be able to borrow up to 90% of your policy’s cash value tax free, although loans reduce the policy’s death benefit and cash value, and may trigger a taxable event if the policy lapses. Cash value insurance is generally more expensive than term insurance.
Universal life is similar to whole life — with the added benefit of potentially higher earnings on the savings component. Universal life policies are also highly flexible with regard to premiums and face value. Premiums can be increased, decreased or deferred, and cash values can be withdrawn. You may also have the option to change face values. Universal life policies typically offer a guaranteed return on cash value. You’ll receive an annual statement that details cash value, total protection, earnings and fees.
Variable life generally offers fixed premiums and control over your policy’s cash value. Your cash value is invested in your choice of stock, bond, or money market funding options.1 Cash values and death benefits can rise and fall based on the performance of your investment choices. Although death benefits usually have a floor, there is no guarantee on cash values. Fees for these policies may be higher than for universal life, and investment options can be volatile. On the plus side, capital gains and other investment earnings accrue tax deferred as long as the funds remain invested in the insurance contract.
Universal variable life insurance is the most aggressive type of policy. Like variable life, you can choose from a variety of investment options. However, there are no guarantees on universal variable policies beyond the original face-value death benefit. These policies are probably best suited to affluent buyers who can afford the risks involved.
Key terms and definitions
• Face value: The original death benefit amount.
• Convertibility: Option to convert from one type of policy (term) to another (whole life), usually without a physical examination.
• Cash value: The savings portion of a policy that can be borrowed against or cashed in.
• Premiums: Monthly, quarterly, or yearly payments required to maintain coverage.
• Beneficiary: The individual(s) or entity (e.g., trust) that is designated as benefit recipient.
• Paid up: A policy requiring no further premium payments due to prepayment or earnings.
Jeremy R. Gussick is a Registered Representative with, and securities and advisory services are offered through LPL Financial, a Registered Investment Advisor, Member FINRA/SIPC.
1Investing in stocks involves risks, including loss of principal. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and are subject to availability and change in price. Investing in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the fund.
This article was prepared with the assistance of DST Systems Inc. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. We suggest that you discuss your specific situation with a qualified tax or legal advisor. Please consult me if you have any questions. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. All investing involves risk including loss of principal. No strategy assures success or protects against loss.
This material contains only general descriptions and is not a solicitation to sell any insurance product or security, nor is it intended as any financial or tax advice. For information about specific insurance needs or situations, contact your insurance agent. This article is intended to assist in educating you about insurance generally and not to provide personal service. They may not take into account your personal characteristics such as budget, assets, risk tolerance, family situation or activities which may affect the type of insurance that would be right for you. In addition, state insurance laws and insurance underwriting rules may affect available coverage and its costs. Guarantees are based on the claims paying ability of the issuing company. If you need more information or would like personal advice you should consult an insurance professional. You may also visit your state’s insurance department for more information.
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