Life Insurance policies are tricky to understand. With all the information available on the internet, it’s easy to become overwhelmed by information overload. So, where do you start first?
First, you should probably decide if life insurance is the right financial move for you right now. There are factors for consideration, which we’ll get into in a moment. If it turns out you need life insurance, then the next step would be to look into your options and get the best value for your money.
We’ll go through the above and more in this article in the simplest way possible.
Ready? Grab a notepad and pen; you’ll need to take some notes.
I | Life Insurance Basics
Definition
Life insurance is a bond between an insurer and a policyholder that guarantees death benefits to the insured’s policy’s beneficiaries.
Life insurance is available for a predetermined period between 5-30 years or for however long you or the insured may live.
Do You Need Life Insurance?
It’s a common question, and the simple answer is it depends.
Your current situation, the purpose of insurance, family life, and age are all determining factors.
- Do you generate a significant percentage of your household income?
- Will your family be able to cover out-of-pocket expenses at your passing?
- Do you already have substantial savings your family can use for funeral arrangements?
- Are you married with a mortgage and other recurring bills?
- Do you have children and would like to safeguard their education?
- Do you have any debt your family may inherit?
- Do you care for an elderly parent or any other relative who depends on you financially for continued care?
On the Matter of Family
A nationwide study on life insurance carried out by the ASA showed that 90% of respondents agreed that a family’s breadwinner needs life insurance. Breadwinners often bring in a chunk of their family’s earnings, and their families feel the pinch in their absence.
Between funeral expenses, monthly utilities, and health care bills, it’s easy to fall into debt. Not everyone plans sufficiently for their future. And as we get older, health complications become an impending reality.
Suppose you have elderly parents without life insurance policies. You can buy life insurance policies with them as the insured with their signed permission and medical records.
While caring for aging parents, the financial burden will fall on you or your siblings. Long-term care insurance safeguards your financial status.
If you are the sole payer of the premiums, list yourself as the beneficiary to secure your investment.
Life Insurance and Wealth
With life insurance, you can maximize the distribution of assets to your beneficiaries. Whereas a will preserves your wealth, distributing your assets as you have accumulated them at the time of your passing, life insurance creates wealth.
Wealth generation reflects in the death benefit disbursed, the entirety of which qualifies for income tax exemption. Death benefits, however, are subject to estate taxes if the total value exceeds the exclusion limit set by law in your state. Only the amount exceeding the exclusion threshold is taxable.
If this is a significant concern, work with an informed advisor to understand your policy’s tax perimeters.
Outside of death benefits, you can sell your life insurance policy. By selling your insurance, you’ll receive a partial settlement, not the total amount your beneficiary would receive at your passing. This option isn’t the best wealth creation method, but it grants you access to the money while alive.
As attractive as the above information may sound, life insurance is not a stable option for wealth creation. Be wary if an agent or insurance company tries to sell it as a “sure” investment. There are many strings attached, which we’ll examine later in this article.
Workplace Life Insurance
With workplace-issued life insurance, you’ll need added protection. Why? If you lose your job, your coverage goes with it. Switching between employers will have the same effect. A private life insurance policy ensures that you’re always protected.
The main issue you’ll face here is the price of buying independent coverage. Group insurance will always be the cheapest option for life or health.
The questions and situations presented in this section will help you decide if you need life insurance. They will also determine the type of policy you’ll need for the best protection and the applicable coverage limit.
Important note: The younger you are, the lower your premiums and the higher the chance of passing your life insurance medical exam.
II | Understanding the Different Types of Life Insurance
Term Life/Pure Life Insurance
Term or Pure Life Insurance allows you the flexibility of determining the length of coverage and your policy limit. With a fixed rate for the coverage term, you can budget for your premiums without fear of surprise increases during the lifetime of your policy.
Most term insurance grants coverage for five to thirty years. Once your policy reaches the deadline, it will expire, and you have the option of renewal. It’s the least expensive option as it only covers death benefits.
More about Term Life
Term Life policies have no value outside of the stated death benefits. Unlike permanent life insurance, it offers no savings or investment options and doesn’t allow for estate planning or charitable donations.
Guaranteed benefits specified on your term policy can cover:
- Healthcare;
- Funeral expenses;
- Consumer debts;
- Mortgage premiums, among others.
Ask your insurance agent for a comprehensive list of areas covered.
Some fine prints apply to this policy. If your term life expires before your death and you decide to renew:
- You won’t get a payout from the expired policy, and there are no rollovers.
- Your new premiums will reflect your age, health, and life expectancy at the time of renewal. In other words, brace for higher premiums.
Each state has a regulatory body that sets the rates insurers can charge on renewed term life policies.
You can convert it into permanent coverage or allow the policy to terminate if you don’t want to renew your term life.
Because most term life policies expire before the policyholder’s death, the reduced chance of payout makes this policy “low risk” for insurers. The lower risk translates into lower premiums than permanent life insurance, which offers you full life coverage.
Term Life Premiums
Several factors determine your policy premiums.
Primary considerations:
- Age
- Health
- Sex
Other factors:
- Smoker vs. non-smoker
- Current medication
- Occupation (high or low risk)
- Hobbies (high or low risk)
- Driving record
- Family history (insurers factor in the possible chance of you falling ill from hereditary diseases into your risk assessment)
Outside influences
Besides the risks directly linked to you, interest rate trends, state regulations, and your insurance company’s financial status also affect your premium.
Every policy issued by an insurer is a game of risks. Insurance companies assess the odds of not having to payout. The riskier it is for them to underwrite your coverage, the higher your premium, no matter the reason.
Types of Term Insurance
Level Term/Level Premium Policies
Offers fixed premiums and death benefits from 10 to 30 years as specified in the policy.
Yearly Renewable Term (YRT) Policies
Renewable every year without proof of insurability. YRT policies have no specified terms as level term policies do.
Premiums start low, but like with term life renewals, your age at the time of renewal increases your premiums. With the reality of yearly increases, YRT policies are unpopular among insurance seekers.
Decreasing Term PolicyThough the policyholder pays a fixed level premium for the specified term, death benefits decline each year on a predetermined schedule.
Decreasing term policies often run in conjunction with a mortgage. The policy matches the declining principal of the home loan.
Is Term Life For You? Or Should You Buy Permanent Insurance?
Point #1: Term life insurance offers substantial coverage at low premium costs. Permanent life insurance provides limited protections with higher premiums.
The catch is that permanent insurance guarantees you “till death” coverage. In contrast, term life comes with renewal conditions, i.e., your health condition at the time of renewal application.
Point #2: Unless your term life comes with “guaranteed insurability,” your insurer may decide to decline your renewal request.
If you develop any significant illnesses during your previous coverage period, your risk factor increases with your new policy. Depending on the nature of the sickness, your insurer may decide to give you a pass with pocket-biting premiums or terminate your policy.
The only sure way you’ll lose your permanent insurance is if you lapse on payments. Otherwise, your policy covers you for life.
Point#3: Term life offers no savings or investment options; permanent life does. For some customers, the investment features numb the pain of high premiums as it opens avenues for wealth creation.
Permanent policies assign a portion of your premiums as ‘cash value.’ Some policies pay dividends, which can be paid out or lodged on deposit within the policy. Over time, your cash value could grow enough to pay your premiums. Talk about a policy paying for itself.
Unique benefits on permanent life include “tax-deferred” cash value and tax-free access to cash payouts.
Consult your financial advisor to determine which policy balances the scales of pros in your favor.
Convertible Term Life
Say you decide to start with a term life policy. One way to secure your insured status and guarantee approval is to set up a convertible term life insurance.
Convertible term life comes with a rider that allows you to convert your term life into permanent life insurance.
Conversion can happen during the period of your current policy or close to its expiration. The process does not include underwriting or proving insurability.
You maintain the original health rating of your term policy, approval guaranteed without a medical exam. Despite your current health condition not affecting your premium rate, it may increase as high premiums are customary for permanent insurance.
Whole Life Insurance
Whole life insurance is the most common life insurance product offered by insurers.
Unlike term life, whole life provides coverage for, you guessed it, your entire life. It guarantees payment of benefits to your beneficiary as long as you maintain premium payments.
The two critical components of this policy are:
- A death benefit, which is payable to your beneficiary at your passing;
- Cash value benefits accumulate over the term of the policy. You can use it as savings or borrow against it when you’re alive if you require the cash.
Types of Whole Life Insurance
Traditional Whole Life Insurance
This policy guarantees a minimum rate of return on your cash value assets.
Interest Sensitive Whole Life Insurance
It offers policyholders adjustable rates on cash value assets and flexibility. You can increase your death benefits without inflating your premiums. Economic conditions and the rate of return on your cash value assets affect the process.
Single Premium Whole Life Insurance
You can purchase simple premium whole life insurance with one lump sum payment. It accrues cash value like the previous options and comes with the same tax shelter provisions on your returns.
Benefits of Whole Life Insurance
- Your premium remains consistent for the duration of your policy unless you decide to change it.
- A percentage of your premium funnels into the cash value of your whole insurance policy.
- You may be able to accumulate enough cash value to pay off your policy premium.
- You get lifelong protection with only your initial medical exam. If you develop any severe illnesses during coverage, it won’t drive up your premiums. You may, however, require another exam if you want to make significant changes to your policy.
- You and your estate can benefit from tax-saving opportunities before and after your death.
Whole Life Premiums
Whole life premiums are higher because it has two purposes:
- A portion goes toward your life insurance, which translates into death benefits.
- And the second portion goes into your investment options.
You’re also paying for your insurance coverage’s guaranteed safety and the other perks like tax-free dividends that you don’t get with a term life policy.
Whole Life Cash Value
Whole life insurance gives you a chance at wealth accumulation through cash value. You can build up your cash value by remitting payments higher than the scheduled premiums or by reinvesting dividends to help you earn interest.
The accumulation factor is a prime selling point and a stand-out difference between term and whole life insurance. Accrued funds can be accessed via cash withdrawals or as loans.
If you choose the loan option, your insurer will recoup the outstanding funds from your death benefit if you lapse on repayment. Deductions will lower the payout for your beneficiary.
Also, by withdrawing the money as is, you decrease your plan’s cash value, but your death benefits remain untouched.
Your insurer also benefits from the increase in your cash value. Say you take out a $30,000 life insurance policy and accumulate a cash value of $15,000. Upon your death, your beneficiary will receive the full payout of $30,000 in death benefit. But the math goes like this:
- Insurer pays: $15,000
- Your cash value pays: $15,000
Alternately, if your cash value sits at $10,000 at the time of your death, the math changes to:
- Insurer pays: $20,000
- Your cash value pays: $10,000
The higher your cash value, the less your insurance company has to fork out as compensation.
Some Ugly Truths about Whole Life
Ugly Truth #1: Though you’ll see it mentioned in this article and others that life insurance is a vehicle for creating wealth, don’t only approach it as such.
Think of the possibility of wealth as the icing on the cake. What’s important is that you set up the best safety net for you and your family. In truth, life insurance cash values accumulate a lower rate of return than other investment-focused options on the market. And this is so even when we factor in the tax-saving benefits.
Whole life insurance may be the best avenue of death benefit plus savings/investment for you, but you need all the facts. Consult with a broker and develop an investment strategy outside your insurance policy.
Take informed risks only.
Ugly Truth #2: Hidden costs will kill you.
These hidden costs come from commission payments brokers earn from whole life insurance. They also include administrative fees for investment management, which significantly reduces your cash value.
Fees are inevitable, but make sure you understand what you’re paying for and what to expect. Ask questions, and go elsewhere if your advisor/broker/agent gives you the runaround or something feels off about their answers.
Savings options like 401(k) offer tax incentives, with high returns and low commissions. Check all of your options. And where possible, keep your investment and insurance policies separate. Putting all your eggs in one basket can lead to significant financial losses.
Universal Life Insurance
Universal Life Insurance mixes the advantages of whole life and term life insurance. It combines the ability to invest and build your savings (whole life) with the flexibility (term life) to choose how to invest a percentage of your premiums and how to use your savings.
It’s a long-term investment strategy that provides you with a life insurance policy while offering the ability to build savings. Because of the investment component, it is generally more expensive than term life insurance.
How Does It Work
Much like whole life insurance, a portion of your premiums will be split between death benefits and investment savings. The advantage is you can adjust your premiums and death benefits.
Premiums
With universal life insurance, you can pay premiums over the cost of insurance (COI). The difference, or the excess monies, is added to your policy’s cash value portion and grows with interest.
When your cash value reaches the required amount, you can skip payments without the threat of a policy lapse.
As you age, the insurance cost will increase—monitor price adjustments. You may have to increase your premiums if your accumulated cash value can no longer cover the COI.
The flexible premiums come with a catch as some insurers may require a single lump sum down payment. Fixed schedule premiums may also apply.
Cash Value
You will earn interest over time based on current market prices or the minimum interest rate for your cash value. As the cash value increases, you can access portions of the accumulated funds without affecting the value of your death benefits.
No taxes apply to funds borrowed against the accumulated cash value of your policy. Unpaid loans will decrease the death benefit by the outstanding amount. Should your loan payment become overdue, your insurance company can deduct monies owed from your cash value.
Taxes apply to any withdrawals from the excess cash value of the policy.
Universal Life and Market Stability
The success of your universal policy investment rests heavily on market stability. The advantages that once made it an attractive option two decades ago have faded with increased financial instability.
If you invest your premiums in unstable markets, you stand to lose big. Your entire investment could be in trouble.
Discuss with your broker the two types of universal life insurance and if Indexed Universal Life is a safer option for you than Traditional Universal Life.
III | How to Shop for the Best Life Insurance
Life insurance prices vary among insurance companies. That is why it’s so important to shop around. You want to ensure you’re balancing premium costs with insurance quality.
Though insurers allow you to buy directly from them, professional help is a plus. Consult a financial planner or broker who can advise you of your options and the best avenue suited for your specific circumstances. As with your home insurance, tailor your life insurance to suit your lifestyle.
Making use of professional help
A financial advisor can cut through the swamp of information faster. They have the experience and far more knowledge than we can fit into a single post. Independent agents sell for various companies and give you sidelong comparisons. If you choose a private agent, do the legwork by requesting estimated quotes.
Don’t fall for low-price options if you use services like Accuquote, LifeInsure, or FindMyInsurance. Not unless reputable and stable insurance providers offer them. Investing your money in anything is risky; ensure the insurer you choose has a solid financial strength rating.
IV | How to Save on Life Insurance
Shop for the best rates: Insurers sell the same coverage packages for different prices. Because the process of searching for and learning about life insurance can be tedious, grabbing the first insurance rate you see might be appealing. Resist the urge.
Short-term gains can lead to long-term financial losses.
Your youth is a premium advantage: Insurance carriers calculate premiums based on age and health conditions. Lock in the best rates at the healthiest period of your life.
If, by chance, you have a preexisting issue, don’t be disheartened. Some insurance companies have ‘specialties’ and offer better rates for specific medical conditions than others. Again, consult a broker or advisor for tailored assistance.
Don’t smoke: Smoking increases health risks and, with it, premium rates. Suppose you purchase a life insurance policy as a smoker and then quit for over twelve months. Most insurance companies will adjust your rates for the “smoke-free” you.
Don’t be dazzled by Whole Life Insurance: It may be the option best suited for you, or it may not. The only way to properly decide is by getting all the facts.
Agents earn massive commissions from selling whole life insurance, and your high premiums pump money into insurance companies. They are going to push the option that suits them the most financially. That’s the ugly side of the business.
Conclusion
Life insurance can protect your family’s lifestyle, build wealth, and secure financial stability. Unlocking these benefits, however, require you to learn and stay informed.
So here are some summary tips to keep in mind:
- With all the risks involved in using life insurance for wealth building, keep your insurance policy and investments separate unless no specific investment option suits you.
- Insurers and agents will tell you whole life insurance is your best option. Still, the high commissions and other hidden costs reduce your possible gains.
- IRAs, 401(k) s, and various other savings options offer similar tax advantages to whole life insurance with penalty-free portability and without high commissions.
- Going cheap with your policy is a risky move. Yes, you don’t want to overspend, but you don’t want to partner with a shady company. Stick with insurers who have documented market stability and will likely be around for your policy’s duration.
- Make sure the policy you choose matches your lifestyle.
- Lock in the lowest premium rates by purchasing a policy when you’re in good health.
- Convertible insurance gives you added control over your policy. Gather as much information as you can on the pros and cons of investing in one.
