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Types of Life Insurance

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Types of Life Insurance

Life insurance protection comes in many forms, and not all policies are created equal, as you will soon discover. While the death benefit amounts may be the same, the costs, structure, durations, etc. vary tremendously across the types of policies.

 

Whole Life

whole life insurance provides guaranteed insurance protection for the entire life of the insured, otherwise known as permanent coverage. These policies carry a "cash value" component that grows tax deferred at a contractually guaranteed amount (usually a low interest rate) until the contract is surrendered. The premiums are usually level for the life of the insured and the death benefit is guaranteed for the insured's lifetime. Any withdrawal you make will typically be tax free up to the amount of premiums you have paid into the policy minus any prior dividends paid or previous withdrawals. Because of their permanent protection, these policies tend to have a much higher initial premium than other types of life insurance.  

Universal Life Insurance

Universal Life Insurance resembles whole life in that it is also a permanent policy providing cash value benefits based on current interest rates. However, the premiums, cash values and level amount of protection can each be adjusted up or down during the contract term as the insured's needs change. Cash values earn an interest rate that is set periodically by the insurance company and is generally guaranteed not to drop below a certain level.

Variable Universal Life

Variable Universal Life Insurance gives the consumer the flexibility of a universal policy along with a selection of investment choices. The mutual fund sub accounts in these policies are technically classified as securities and are therefore subject to Securities and Exchange Commission (SEC) regulation and the oversight of the state insurance commissioner. The investment risk in these policies lies with the policy owner; as a result, the death benefit value may rise or fall depending on the success of the policy's underlying investments. However, policies may provide some type of guarantee that at least a minimum death benefit will be paid to beneficiaries.

Term Life
One of the most commonly used policies is term life insurance. It pays the face amount of the policy, but only provides protection for a definite, but limited, amount of time. Term policies do not build cash values and the maximum term period is usually 30 years. They are useful when there is a limited time needed for protection and when the dollars available for coverage are limited. The premiums for these types of policies are significantly lower than for any type of cash value policy. They also (initially) provide more insurance protection per dollar spent than any type of permanent policy. However, the cost of premiums increases as the policy owner gets older and as the end of the specified term nears. Term polices can have some variations, including, but not limited to:

  • Annual Renewable and Convertible Term: This policy provides protection for one year but allows the insured to renew the policy for successive periods thereafter, but at higher premiums without having to furnish evidence of insurability. These policies may also be converted into whole life policies without any additional underwriting.
     

  • Level Term: This policy has an initial guaranteed premium level for specified periods; the longer the guarantee, the greater the cost to the buyer (but usually still far more affordable than permanent policies). These policies may be renewed after the guarantee period, but the premiums do increase as the insured gets older.
     

  • Decreasing Term: This policy has a level premium, but the amount of the death benefit decreases with time. This is often used in conjunction with mortgage or other debt protection.

Many term life insurance policies have major features that provide additional flexibility for the insured/policyholder. A renewability feature, perhaps the most important feature associated with term policies, guarantees that the insured can renew the policy for a limited number of years (i.e., a term between five and 30 years) based on attained age. Convertibility provisions permit the policy owner to exchange a term contract for permanent coverage within a specific time frame without providing additional evidence of insurability. Of course, these provisions will raise the policy premiums accordingly.

The Bottom Line

Many insurance consumers only need to replace their income until they've reached retirement age, have accumulated a fair amount of wealth, or their dependents are old enough to take care of themselves. When evaluating life insurance policies for you and your family, you must carefully consider the purchase of temporary versus permanent coverage. There are many differences in how policies may be structured and how death benefits are determined, as well as how they are priced and their duration.

Many consumers opt to buy term insurance as a temporary risk protection and then invest the savings (the difference between the cost of term and what they would have paid for permanent coverage) in a brokerage account mutual fund or retirement plan. In some cases, this is a good idea, but it is not necessarily always the best option, especially for those who must rely on at least a certain amount of coverage when they die.



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