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Most people don’t understand life insurance and don’t want to understand it – and that’s dangerous. Here is useful information put together by insurance expert and Orlando DUI attorney Bill Umansky, about the major categories of life insurance policies that will help you ask better insurance questions – and help you do what’s best for you and your family.
Get An Agent
With almost 2,000 companies selling life insurance, choosing the best policy can be confusing. Your insurance agent is the key. Seek out someone with whom you feel easy, who has excellent credentials and who wants to have a long-term relationship with you.
The Basics
There are two basic classifications of life insurance – term and permanent. The most common types of permanent insurance are whole life, universal life, and variable life. For a first-time buyer, each classification has its own strengths and weaknesses to consider in light of your family and financial situations. Let’s look at each of these categories, their drawbacks, and ideal candidates.
Term Insurance
A term insurance policy gives you protection for a specified time – usually up until age 70. The insurance premium is used to purchase risk coverage after expenses are deducted from the premium. Although premiums generally increase at stated intervals over time, the annual premium for term insurance has a much lower out-of-pocket cost initially than the premium for comparable whole life insurance purchased at the same age.
Term drawback I:
Some term policies have reentry provisions, whereby you have to re-qualify medically every four, five, or ten years to keep your premiums at the lower term levels.
Term drawback II:
The term insurance premiums increase periodically as you become older.
Term drawback III:
Once you are over age 55, it can be quite expensive to acquire this kind of insurance.
Ideal candidates:
People who require protection for specific purposes, such as mortgage payments or college tuition, and can’t afford whole life insurance.
Whole Life Insurance
A whole typical life, or ordinary life, the policy covers you for your entire life and offers a guaranteed death benefit – a fixed sum payable to your heirs when you die. Some whole life policies pay dividends, which can:
- Reduce your premiums.
- Buy paid-up additions to your fife insurance policy to increase your death benefit.
- Be returned to you in cash.
- Be deposited with the insurance company, where it will earn interest and serve as an additional savings account.
When you get a whole life policy, part of the premium pays the actual cost of the insurance risk; part pays the insurer’s expenses, and part goes into a reserve fund known as cash value. This cash value, which allows the premiums to remain level during your lifetime, builds up annually and grows in value on a tax-deferred basis. Insurance companies are not obligated to tell you how your premium dollar is divided.
Because of the conservative nature of life insurance, various state regulations, and the desire of insurers to fulfill their obligations, these guarantees are very low. But your actual cash available is usually higher than that which is guaranteed in the policy if your dividends are used to purchase more insurance or are left in savings accounts with the company.
The most widely used whole life contract insures one life and pays a death benefit to the beneficiary upon his/her death. A newer variation is called second-to-die insurance, which ensures two lives and pays the death benefit when the second person dies. The cost of a second-to-die policy is lower than that of two individual policies.
Whole Life drawback I:
The premiums for a whole life policy are higher than those for a term policy because some of the money goes toward cash value.
Whole Life drawback II:
Not all whole life policies pay dividends. And even when dividends are paid, they are not guaranteed but rather reflect the insurance company’s earnings, net of expenses.
Ideal candidates:
Individuals with estates of more than $600,000 or couples with a combined estate of more than $1.2 million will be hit with estate taxes upon the death of the surviving spouse.
Universal Life Insurance
Universal life insurance is a variation of whole life insurance. However, in a universal life plan, the cash value and the actual insurance cost are unbundled.
Thus, the premium is used first to pay for insurance protection and expenses. Any excess amount is held by the insurance company at an annually predetermined rate of interest. The minimum rate – about 4% now – is guaranteed by the contract, but it is the current rate that is actually credited to your account.
Universal Life drawback I:
Watch out for interest rates since the investment return on your cash value is tied to them. When rates are high as they were in the 1980s – universal life insurance looks more attractive than whole life insurance. When rates are low – as they are now – whole life insurance looks more attractive. This difference is most apparent in the first ten years of the policy.
Universal Life drawback II:
Unless you have a lot of self-discipline, you may not put aside enough each year in premium payments, which could mean that your death benefit won’t be as high as you’d like it to be – or you have to come up with larger and larger premium payments to make- up the difference and keep the same death benefit.
Ideal candidates:
The same people might buy whole life insurance but want premium flexibility and the ability to see how their premiums are used.
Variable Life Insurance
Variable life insurance is also a modification of the traditional whole life insurance concept. However, the rate of return on the cash value portion is not determined by the insurance company; instead, it’s dependent on earnings of “mutual funds” within the contract selected by the insured.
Companies selling variable life policies generally give you a choice of several such funds, ranging from the most conservative to the most aggressive.
Variable Life drawback:
While there are fixed premium payments and a guaranteed death benefit, there is no minimum guaranteed cash value. That’s because, with variable life insurance, you assume the investment risk yourself and, therefore, could wind up with little or no cash value if the stock market declines.
Ideal candidates:
People who are risk-oriented and willing to participate in the sometimes fast-moving securities markets.
The Cost Of Conversion
Many term insurance policies can be changed to other types of insurance, regardless of your health at the time. But before you even consider a conversion, consider the following:
- The cost of a permanent contract is always greater than a term policy issued at the same age.
- You usually cannot convert a permanent policy to a term policy without a medical examination or questionnaire. On the other hand, the conversion from term to whole life insurance is normally guaranteed contractually without any medical requirements.
- The conversion to a permanent life insurance policy by the same company that issued the term policy may actually be more expensive than simply purchasing a new policy from a different company.
- Be sure that the new policy is in place before dropping coverage on the old one.
When It Pays To Convert
You should think about converting a term policy to a permanent one under two scenarios:
- When you can afford a tax-sheltered savings account:
- Ask for a realistic comparison illustration for this type of policy showing the current interest rates. Select one that is two percentage points less. This will help show what your return might be starting at that moment.
- When you have a number of small policies:
- Exchanging them for a single large policy with equal or greater tax death benefits may be financially advantageous – if you’re in good physical condition.
The Bottom Line
Life insurance planning and purchasing should relate to your objectives at prominent points in your life cycle. That’s why it is so important to deal with a professional insurance agent or financial advisor for guidance and advice.
