Do you need life insurance? A valid question that not too many of us thoughtfully consider. Many employers offer the option to enroll in group life insurance when starting a new job. The process seems pretty straightforward—visit human resources, complete the forms and name a beneficiary. Unfortunately, most people don’t think about life insurance again until they need it.
What is Life Insurance?
Life insurance, like most insurance, is a contract between the insured and the company providing insurance. The insurance company will pay out a specified amount (death benefit) upon the insured’s death if the contract is intact and all payments have been made. The insured agrees to pay premiums at an agreed-upon interval, duration, and maximum amount in exchange for the death benefit. The death benefit is intended to compensate the beneficiaries for the economic loss incurred as a result of the insured’s death.
Life insurance is a tool that should serve a purpose. Understanding its purpose and coordinating it with other components in your estate plans helps ensure peace of mind for you and your loved ones should you pass away sooner than expected.
Several types of life insurance serve different economic purposes.
Types of Life Insurance
Term life insurance pays a benefit only if the insured dies during the period or term the insurance is in force. For example, suppose Mark is the primary breadwinner in a family of four. His youngest child is five years old. He and his wife have purchased a term life insurance policy covering him for the next 15 years. If Mark should die in the next 15 years, the insurance policy will pay out a death benefit, assuming the contract terms are met. As a result, Mark and his family will have peace of mind knowing that they will be financially supported if Mark dies before his children reach adulthood.
Whole Life Insurance
Whole life insurance guarantees a consistent premium will be paid for the duration of the contract. However, this benefit comes at a higher price than term life insurance. In addition, the insurance company must maintain a reserve to help keep the premiums level during the insured’s lifetime. Since this reserve is accumulated cash value within the policy, the policy owner can borrow against it or cash it out if they choose to terminate the policy before they die. Whole life insurance can be customized in several ways.
Universal Life Insurance
Because universal life insurance policies are interest-sensitive, they can provide higher death benefits and cash value over the policy’s life. However, the benefits will be determined by the investments, expense, and mortality factors that are built into the policy. Furthermore, because the policy varies with interest rates, there is the potential for greater gains in cash value and greater losses.
With universal life insurance, if the investments perform poorly and cannot cover the expenses and mortality costs associated with the policy, it will terminate. Compared to whole life policies, universal life policies are usually more flexible regarding making premium payments and withdrawing cash value.
When selecting universal life insurance, it is essential to consider the type of cash flow you require and the risk you are insuring against to ensure it is the best policy option to meet your needs. Depending on the insurer, there is almost an unlimited number of variations of universal life policies.
Variable Life Insurance
Variable life insurance policies are structured similarly to traditional whole life policies, with the exception that neither the death benefit nor the surrender value are guaranteed in variable life policies. The surrender value is the amount left over after fees when you cancel the life insurance.
Both the death benefit and the surrender value can rise or fall depending on the performance of the policy’s underlying investments. There is, however, a minimum death benefit that beneficiaries receive upon the death of the insured even if the asset performance is poor.
Variable life insurance policies give policyholders a lot of control. The policy’s cash value may be invested in stocks, bonds, real estate, and money market portfolios. While the policy premiums are typically fixed, the cash value can fluctuate depending on the underlying asset’s performance.
The death benefits for variable life insurance, like other insurance policies, are tax exempt. The earnings on the assets and the accumulated cash value are income tax-deferred until the policy is surrendered. The policyholder can also borrow up to a certain percentage of the policy’s cash value if they need cash for a period of time. While the load is outstanding, interest is charged.
Variable Universal Life Insurance
Variable universal life insurance is a cross between variable life and universal life insurance. It can incorporate the best features of both types of life insurance.
- Flexible premiums
- Adjustable death benefits
- Control over investment choices within the policy
- Ability to borrow against the cash value
- Ability to withdraw part of the cash value
Both variable life policies and variable universal life insurance policies are regulated by the Securities and Exchange Commission (SEC) because of their flexible investment options.
Survivorship Life Insurance
Survivorship life insurance policies are intended to be used when financial benefits are needed only after the death of a second party, such as both parents or a married couple. Survivorship policies are frequently considered when a married couple owns significant real property and wishes to keep the property in the family and pay estate taxes through the insurance policy rather than by selling the property.
Survivorship insurance policies can be:
First-to-die Life Insurance
In contrast to survivorship policies, first-to-die policies pay the death benefit upon the death of the first of two insured individuals. Insuring two people under one policy is less expensive than having two separate life insurance policies. For example, if two people co-own a company, they may choose to have a first-to-die policy. If one of the co-owners dies, the other co-owner can use the death benefit to purchase the deceased partner’s share of the business from their beneficiaries.
Single Premium Whole Life Insurance
A single premium whole life policy enables a person to pay a single cash payment for a specific amount of insurance that will cover them for the rest of their lives. As is customary with whole life insurance, the insured can borrow against the policy’s cash value or surrender the policy.
It would be necessary to consider whether surrendering the policy has income tax consequences or benefits. For example, if the policy matures and pays out upon the insured’s death, there may be significant income tax benefits. Another possible advantage in some states is that the cash value of the life insurance policy may provide substantial asset protection against future creditor claims.
Which Life Insurance Type is Best?
Because you must consider your financial situation, stage in life, and the financial needs of your beneficiaries, there are numerous options to weigh. Consider the following:
- Amount of spare income
- Expenses such as a home or school loan
- Ages of any children
- Risk for chronic disease
- Owning a large estate that may be hard to sell
- Owning a business with a co-owner
- Tax obligations
An insurance professional, financial advisor, or estate planning attorney may be able to provide additional considerations that can help you identify your risks and determine which type of policy may be your best choice.