October 2018: Life Insurance
In the investment advisory industry, we often get questions about life insurance. Typically, people want to know why they should insure themselves, the different types of life insurance, and how much coverage they should have. When it comes to life insurance, everyone has their own unique situation and depending on who you seek advice from, you may be advised different ways. However, it may be good to know some basics before you decide to shop around for coverage.
What does life insurance do and cover?
Life insurance is an agreement between a life insurance policy owner and an insurance company that insures the life of a specific person. The policy owner pays the insurance company a fee called a premium for a set payout called the death benefit. In the event the insured person dies, the insurance company will pay the death benefit to the listed beneficiaries. There can potentially be three or more parties to an insurance policy: The insurance company, the insured person, the policy owner (which can also be the insured) and the beneficiary(s).
Term, Whole Life, Universal, what’s the difference?
Term Insurance-This is an insurance policy that has set premiums for a specific period of time, that is agreed upon at the inception of the policy. Once that period ends, the policy is no longer valid. Term policies are usually the least expensive form of life insurance. Term policies typically offer lower premiums for the same death benefit versus their whole life counterpart. Term policies are less expensive because the policy is for a limited time and the premiums are only buying the insurance.
Whole Life- This type of life insurance remains intact, as long as the premiums are paid or until the death of the insured. Whole life policies also have a cash value element that can prove to be a powerful tool. You can read more about cash value accounts at Investopedia. Generally, whole life policies are more expensive than term insurance because you are insuring someone through a specific policy until their death, you’re purchasing the insurance, there is a contribution to the cash value account.
Universal Life- Is a whole life policy that allows the owner to alter the premiums they pay and/or the prospective death benefit while the policy is still intact. Ultimately, Universal Life was sold as a cheaper whole life policy with more financial freedom and the ability to build up cash tax-deferred. However, as the Wall Street Journal covered here, these policies have a lot of fine print to them that may impact the insured’s desired outcome.
Why have life insurance coverage?
As we stated above, every person has their own unique situation. However, if other people or entities rely upon you being alive, then it may be time to consider life insurance coverage.
It helps to ask yourself the following questions:
Do you have family members that rely upon your income stream?
If you were to die, can your family afford the burial expenses?
Does someone rely upon you to cover and pay for a debt (i.e. Mortgage)? Or does the bank require a life insurance policy to be in place in order to qualify for a particular loan?
Do you have a business that relies upon you significantly?
Are you exposed to malpractice lawsuits?
If you answered yes to any of the questions listed above, then you should consider life insurance coverage.
How much coverage should you get?
Determining your correct amount of life insurance coverage is not an exact science. It is based upon your specific circumstance and certain factors. These factors include: age, income, debt, lifestyle, future lifestyle, children’s expenses, business ventures, and the list goes on. First, if your employer offers a group life insurance plan, usually it is a good idea to enroll in the group plan as it is typically the easiest and cheapest life insurance available. However, that policy’s death benefit may not be enough for your particular situation and you may not be able to keep it if you change employers. Therefore, it may be beneficial to add other coverage through an independent insurance agent. Be mindful when seeking advice from an insurance agent, it may be helpful to ask the agent what they will receive if you purchase the insurance policy through them.
Second, should you buy a term policy or whole life policy? For most people, term insurance can properly cover their life insurance needs. Typically, life insurance is needed during the period of time when you and your family are exposed to the most risk. This period is usually characterized by a high mortgage balance, young children and low retirement savings. But, after this period of time, the need for an additional life insurance policy is typically low. Therefore, term insurance policy that gets you through this specific period of time should effectively cover your insurance needs. Because term insurance policies have lower premiums for the same death benefit when compared to whole life, it is tough to argue against using term insurance. Ultimately, a policy that will provide resources to pay for the major liabilities created due to your death, should be sufficient. For example: A death benefit that covers your outstanding mortgage balance, maybe enough funds that cover your stream of income for a number of years, funds for future major expenses like college tuition, or even help with the lost of business due to your death.
The case for whole life policies is that they may be more affordable in the long run if you chose to carry your policy for the rest of your life because you will not have to re-qualify for insurability. Also, a whole life policy may offer a tax deferred savings vehicle because of the cash value accounts built into these policies. Typically, whole life policies require you to pay larger premiums for the same amount of coverage as their term counterpart, have a fluctuating rate of return on the cash value accounts, and require the policy owner to pay interest if you pull any cash from the cash value accounts. Ultimately, whole life policies are best served for a limited group of people: families passing large estates, wealthy people looking to maximize another tax-deferred account and doctors protecting their wealth from potential malpractice lawsuits. For the average person that is just looking to protect their family in case something happens to them, term insurance may be sufficient. For additional questions and consultation about life insurance, please contact us.
The Difference Between Term and Whole Life Insurance by Nerd Wallet
What are the Principal Types of Life Insurance by Insurance Information Institute.