The Science of Aging Well: How Your Beliefs Affect Your Health
It is inevitable that each of us will die one day. If someone will suffer financially when you die, chances are you need a life insurance policy to help support your family after your death.
Perhaps you already have a life insurance policy, but is it enough?
When was the last time you examined your life coverage needs?
Do you have the right type of life insurance policy?
Understanding life insurance policies isn’t always easy and it can be hard to make sense of the different plans and terms.
Today we are going to review the reasons why people might buy a life insurance policy and discuss the pros and cons of four types of life coverage plans:
- Term life
- Universal life
- Variable life
- Whole life
Reasons Why People Buy a Life Insurance Policy
According to the LIMRA 2013 Insurance Barometer Study, nearly one third of consumers don’t believe they have enough life insurance coverage and that nearly three out of 10 consumers wish their spouse or partner had more coverage
The study notes the top six reasons why people buy life insurance:
- Cover burial and final expenses (89 percent)
- Replace lost wages or income (61 percent)
- Transfer wealth or leave inheritance (59 percent)
- Help pay off mortgage (51 percent)
- Estate taxes or estate liquidity (45 percent)
- Pay for home expenses (43 percent)
Types of Life Insurance Policies
When you are shopping for a life insurance policy you’ll likely encounter the following types of life insurance coverage plans.
Term Life Insurance Policy
Term life Insurance is exactly what it sounds like. You purchase life insurance for a specific term, or set amount of time. You pay premiums for the entire length of the term and once the term is up, your death benefit is gone.
Term life does not have a cash value component so your entire premium is simply used to keep the policy active. Once the term is up, you stop paying premiums and the policy expires. This is what makes term life one of the most inexpensive life insurance policies.
Term life policies are usually far less expensive than other policies such as whole, universal, or variable life insurance. They have a specific coverage period such as 10, 15, 20, 25, and 30 years, allowing you to buy coverage based on your needs.
However, term life offers you no cash value component. Your premiums only go towards the policy and don’t earn interest or accumulate.
Having a specific term can also be a disadvantage. If you purchase a 20 year term policy but decide that you’d like to extend your coverage after the 20 year term you may need to undergo proof of insurability and could be denied additional coverage or renewals could be at significantly high premiums.
Universal Life Insurance Policy
Universal life coverage adds to term life by including a cash component. With this policy, instead of only selecting a specific term and putting it all toward the policy, part of the premium actually goes into a cash account in the policy. This cash account earns interest and the accumulations are tax-deferred.
Universal life coverage provides additional flexibility because of its cash component. You can actually temporarily stop making your premium payments as long as the cash value can cover the cost of the insurance.
Universal life coverage allows you to increase or decrease the death benefit over time. Usually, you can also borrow against the policy in the form of a loan.
Because of these additional advantages and flexibility, universal life policies are more expensive than term life policies. While some of the additional cost goes into building cash value in your account, the rates you earn on this money may not always be the best available rates.
Variable Life Insurance Policy
Variable life insurance is very similar to universal life with one major difference.
With a variable life policy you don’t earn a specific rate of interest in a cash value fund, but instead you can invest this portion in investments such as mutual funds. This allows you much more control and you can choose where to invest the cash value portion. You’re also still guaranteed the minimum death benefit as long as you keep up with the minimum premiums.
However, putting part of your policy in investments such as mutual funds can be risky. If the market crashes you risk the loss of a significant amount of money and put your policy in jeopardy as a result.
A substantial drop in your account value could result in you paying additional premiums to maintain your contract.
Additionally, expenses associated with the investments in this policy may be higher than you might pay elsewhere.
Whole Life Insurance Policy
A whole life coverage plan insures you for your whole life. Like universal life coverage, whole life has a cash value component. Generally, whole life policy premiums and death benefit are fixed.
One advantage of this policy is that cash value also grows tax-deferred and typically allows for withdrawals and loans against the policy.
Since you have a guaranteed premium, interest rate, and death benefit for the life of the policy, there are no surprises. However, these guarantees make whole life coverage usually more expensive than both term life and universal life policies.
The interest earned on the cash value account may be less than you could get if you invested elsewhere.
A whole life policy is not flexible. If you determine that you need more coverage or would like to increase or decreases your premium, chances are you probably can’t with this policy.
Which Life Insurance Policy is Right For Me?
As you can see, there are several options to consider when it comes to life insurance policies.
Take the time to consider all your coverage needs, and how they fit in with your overall financial plan. Then, work with your insurance company, ask them all your questions regarding life coverage, so you can make sure to get the policy that’s right for you.
photo credit: Paradise Bridge via photopin (license)
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