Life Insurance is usually last on the list of important-but-necessary items people want to spend money on, because let’s face it, no one wants to dwell on the circumstance of death. In the wake of the recent recession people have even less insurance than before; which leaves families unprepared to cope with potential tragedy. The universal perception behind life insurance is that it costs more than it actually does, so individuals and families think it won’t fit into their budget. For example: A healthy 35 year old male can buy a 20-year term policy with a $250,000 payout for around $300 per year. Pricing aside, the real question comes down to how much life insurance to take out.
How much life insurance you should have is a very personal decision. Let’s try and closely estimate an amount of insurance that will provide the financial security that you consider important. A general rule of thumb is your life insurance coverage should equal 8-10 times your annual income. Let’s see how it compares to the worksheet below.
Now that you have a picture of how much life insurance you need, let’s take a look at the different types of policies available to you.
Whole Life Insurance remains in force for the insured’s ‘whole life’ and requires premiums to be paid every year into the policy. The policy pays a stated, fixed amount upon your death and part of your premium goes toward building cash value from investments made by the insurance company. Cash value builds tax-deferred each year that you keep the policy, and you can borrow against the cash accumulation fund without being taxed.
Universal Life Insurance is also a type of permanent life insurance. The excess of premium payments above the current cost of insurance is credited to the cash value of the policy. The cash value is credited each month with interest, and the policy is debited each month by a cost of insurance charge, as well as any other policy charges and fees which are drawn from the cash value, even if no premium payment is made that month. Interest credited to the account is determined by the insurer, but has a contractual minimum rate (often 2%). When an earnings rate is pegged to a financial index such as a stock, bond or other interest rate index, the policy is an ‘equity indexed universal life’ contract.
- Single Premium Universal Life is paid for by a single, substantial, initial payment. Some policies do not allow any more than the one premium contractually, and some policies are casually defined as single premium because one premium was intended to be paid.
- Fixed Premium Universal Life is paid for by periodic premium payments associated with a no lapse guarantee in the policy. Sometimes the guarantees are part of the base policy and sometimes the guarantee is an additional rider to the policy. Generally these payments will be for a shorter period of time than the policy is in force; for example payment may be made for 10 years, with the intention that thereafter the policy is paid-up. But it can also be permanent fixed payment for the life of the policy.
- Flexible Premium Universal Life allows the policyholder to vary their premiums within certain limits. Inherently Universal Life policies are flexible premium, but each variation in payment has a long term effect that must be considered. In order to remain active, the policy must have sufficient available cash value to pay for the cost of insurance. Higher than expected payments could be required if the policyholder has skipped payments or has been paying less than originally planned. It is recommended that yearly illustrative projections be requested from the insurer so that future payments and outcomes can be planned.
Variable Life Insurance provides permanent protection to the beneficiary upon the death of the policy holder. This type of insurance is generally the most expensive type of cash-value insurance because it allows you to allocate a portion of your premium dollars to a separate account comprised of various instruments and investment funds within the insurance company’s portfolio such as stocks, bonds, equity funds, money market funds and bond funds. In addition, because of investment risks, variable policies are considered securities contracts and are regulated under the federal securities law; therefore, they must be sold with a prospectus. The major advantage to variable policies is that they allow you to participate in various types of investment options while not being taxed on your earnings (until you surrender the policy). You can also apply the interest earned on these investments toward the premiums, potentially lowering the amount you pay. However, due to investment risks, when the invested funds perform poorly, less money is available to pay the premiums, meaning that you have to pay more than you can afford to keep the policy in force. Poor fund performance also means that the cash and/or death benefit may decline, though never below a defined level. Also, you cannot withdraw from the cash value during your lifetime.
Term Life Insurance provides coverage at a fixed rate of payments for a limited period of time, the relevant term. After the term expires, coverage at the previous rate of premiums is no longer guaranteed and the client can potentially obtain further coverage with different payments or conditions. If the life insured dies during the term, the death benefit will be paid to the beneficiary. Term life insurance is the least expensive way to purchase a substantial death benefit on a coverage amount per premium dollar basis over a specific period of time.
- A version of term insurance is annual renewable term (ART). In this form , the premium is paid for one year of coverage, but the policy is guaranteed to be able to be continued each year for a given period of years. This period varies from 10 to 30 years, or occasionally until the age of 95. As the insured ages, the premiums increase with each renewal period, eventually becoming financially unviable as the rates for a policy would eventually exceed the cost of a permanent policy.
- A more common form of term life is guaranteed level premium term life insurance, where the premium is guaranteed to be the same for a given period of years. The most common terms are 10, 15, 20, and 30 years. In this form, the premium paid each year remains the same for the duration of the contract. Most term life policies include an option to convert the term life policy to a Universal Life or Whole Life policy. This option can be useful to a person who acquired the term life policy with a preferred rating class and later is diagnosed with a condition that would make it difficult to qualify for a new term policy. The new policy is issued at the rate class of the original term policy. (Note that this right to convert may not extend to the end of the Term Life policy. It may extend a fixed number of years or to a specified age, such as convertible to age 70.)
- Return Premium Term Life Insurance is a form of coverage that provides a return of some of the premiums paid during the policy term if the insured person outlives the duration of the term life insurance policy.
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