The type of life insurance you need depends on what you are trying to protect, whether it’s family, your business or estate.
In this article, we’ll help you answer your questions about the types of life insurance available and what factors you should consider before you buy life insurance.
Types of Life Insurance
- Term Life Insurance
- Return of Premium Term Life
- Universal Life Insurance
- Index Universal Life Insurance
- Whole Life Insurance
According to the life insurance research firm LIMRA, 50 million families in the U.S. recognize that they need more life insurance, but don’t know what types of life insurance or how much life insurance they should buy.
Term Life Insurance
For the vast majority of people needing life insurance, term life insurance is the best choice.
Term life provides the maximum death benefit for the lowest possible price in almost all situations.
The most common term lengths available are 1,5,10,15,20,25 and 30 year term length. The term length tells you how long the price is guaranteed for.
Other term options exist, including a company that offers 16-19 year term and a 35 year term.
Term Life Features and Benefits
In addition to price, look for the following when buying term life insurance:
- Company Ratings – Look for ratings from AM Best, Moody’s, S&P and Weiss ratings.
- Conversion Privilege – Conversion allows you to exchange the term life insurance policy for a universal life or whole life insurance policy without having to go through medical underwriting.
- Policy Riders – Riders such as a child rider, waiver of premium rider, long term care rider, accidental death benefit rider, and accelerated death benefit riders may appeal to you.
- End of Term Options – Depending on the company, the premium will increase substantially at the end of the term or keep the premium near the term premium but decrease the death benefit.
Return of Premium Term Life Insurance
A return of premium or ROP for short, is a term life policy that refunds all your premiums paid at the end of the term.
While the ROP option is more expensive than a traditional term life policy, it may appeal to someone who likes the idea of getting money back.
Pricing for ROP term life is typically 4-5 times more expensive than a traditional term life policy vs. a universal life insurance policy that may be 5-6 times more expensive than a term policy.
Something to be aware of regarding ROP term is that not all company’s products work the same way. ROP term may work well for people receiving the best rate classes, but not as well with other rates.
The reason why is some companies only refund the base premium to you at the end of the term. If you’re paying more due to a health issue, the refund may be a partial refund.
Universal Life Insurance
When it comes to life insurance, no product has been more widely touted as the answer to your financial needs than universal life insurance….or vilified as a big ripoff to be avoided at all costs. So, which one is it?
What is Universal Life Insurance?
Universal life insurance is a flexible premium, adjustable death benefit life insurance policy that offers the possibility of lifetime death benefits and cash value accumulation that may be used later on in life for things such as supplemental retirement income, college funding, business funding, and more.
Universal Life Insurance Pros and Cons
Universal life insurance may be a great product in some situations, but is definitely not for everyone. We’ll show you the pros and cons of universal life insurance.
The Pros of Universal Life Insurance
Lifetime Death Benefit – Some universal life insurance policies offer no lapse guaranteed death benefits to age 120. Other universal life policies offer non-guaranteed lifetime death benefits provided the cash value in the policy is sufficient to support the policy for your entire life.
Cash Value – Some universal life insurance policies offer the potential for cash value accumulation over time. The benefit of this is tax free or tax deferred access to the cash value of the policy later on in life.
You may access cash value using loans to supplement retirement income, fund college education costs, provide benefits to employees of your business, etc.
The interest rate credited to your policy each year may be a fixed rate or an indexed interest rate tied to the performance of a stock index.
Tax Deferral Potential – The appeal of cash value life insurance is that you may accumulate cash inside of the life insurance policy until the time you need access to it.
At that time, you may withdraw cash value from the policy in the form of policy loans.
Policy Loans – Another pro of universal life insurance is the availability to take out loans against the cash value of your life insurance policy. While each contract is worded differently, the general advantage of universal life policies is that you may take a loan against your cash value, and it’s not a complicated process like obtaining a loan from a bank.
Flexible Premiums – Premiums may be flexible, allowing you to vary the premium you pay, or to skip a premium payment if needed. There is less flexibility in the earlier years of a policy when there is less cash value accumulated in the policy.
Favorable Underwriting – In some cases, especially high risk life insurance cases, life insurance companies are willing to offer better underwriting rate classes when you buy universal life insurance vs. term life insurance. The more favorable underwriting programs may provide premiums that are competitive with term life premiums.
The Cons of Universal Life Insurance
Expensive – Universal life insurance costs more than term life insurance in most cases. It is reasonable to expect that the premium you pay for a universal life insurance policy will be 4-5 times more expensive than a term life insurance policy.
Guarantees and Non-Guarantees – Most ul policies offer guaranteed performance and non-guaranteed aspects. Interest rates, cost of insurance expenses, administrative expenses, participation rates, and crediting rates may vary from year to year. If you buy a life insurance policy based on non-guaranteed performance, you may need to pay additional premiums if the policy does not perform.
Fees and Surrender Charges – Universal life insurance policies have fees and expenses built into the policy that will affect cash value growth and performance. Many of the expenses such as surrender charges are greatest in the early years of the contract.
It’s important for you to know that if you cancel a universal life insurance policy, you do not receive the accumulation value, you receive the cash surrender value which may be significantly different.
The Greatest Benefits Don’t Happen Overnight – Something to keep in mind with universal life insurance policies is that it requires a long term commitment on your part. It typically requires 10-15 years before the cash value accumulates to a point where you may use it to borrow against.
Taxable Events – If you make a mistake with your universal life insurance policy, the tax deferral provisions may vanish. If you have a policy loan outstanding on your policy and cancel or lapse the policy, it may trigger a taxable event on the loan.
Another issue that may trigger taxable events occurs when you try to put too much money into the life insurance policy, which may trigger a designation called a MEC – Modified Endowment Contract. When this occurs, you may lose the tax deferral benefits of the life insurance policy.
We do not give tax advice, so please consult your tax expert for your individual circumstances.
In summary, you need to carefully weigh universal life insurance pros and cons before you consider this option. It works well for certain cases, but will not work in all situations.
Index Universal Life Insurance
Index universal life insurance may be right for you if you are looking for a cash value life insurance policy, but want the potential for your cash value to grow faster than a traditional whole life or universal life insurance policy.
What is Index Universal Life Insurance?
Index universal life insurance is a cash value life insurance policy where the cash value growth is tied to the performance of an index such as the S&P stock index.
Should You Consider Index Universal Life Insurance?
If you decide that you would like a cash value type of life insurance policy, an index universal life insurance policy may be worth considering.
The most important aspect of your life insurance planning is to make sure you have enough life insurance to meet your needs.
Index Universal Life Insurance Advantages
When compared to a traditional universal life insurance policy, a potential advantage of index universal life insurance is the potential to grow your cash values above and beyond a universal life insurance policy.
Index Universal Life Insurance Disadvantages
A potential disadvantage of index universal life insurance is that if the stock index used to determine performance does poorly, you may end up with a zero return with your index universal life insurance, compared to a traditional universal life insurance policy that has a guaranteed minimum interest rate.
If the index performs poorly, you may have to pay additional premiums in order to keep your index universal life insurance policy in-force.
Complicated to Understand – Index universal life insurance is complicated to understand. There are many moving parts to an index universal life insurance policy.
Specifically, index universal life policies are tied to the performance of stock indexes such as the S&P 500, DJIA, Nasdaq 100, Euro Stoxx 50, Hang Seng, Russell 2000, U.S. Bond Index, and more.
Illustrations for index universal life insurance policies may be 15-30 pages long.
Should You buy Index Universal Life Insurance?
We are big believers in “buy term insurance and invest the difference.” With that being said, there are times when an index universal life insurance policy is a good option.
Before you buy an index universal life insurance policy, look at your other options available such as funding your 401k and other retirement options at higher levels…you may find that a 401k, especially if you have an employer match is a better option for your money than a life insurance policy.
Some business owners and other high income earners who have reached contribution limits with their other retirement vehicles, find an index universal life policy to be an attractive option for them.
Whole Life Insurance
Imagine a life insurance policy that provides a death benefit for your beneficiaries, builds cash value, generates policy dividends, defers taxes, and provides potential tax free cash distributions via policy loans.
It’s called whole life insurance and maybe it’s right for you.
Buy term and invest the difference
If you have ever considered life insurance, no doubt you have heard someone say “buy term and invest the difference”
But did you really invest the difference?
If you did, great…..but how are those investments doing? What if you didn’t invest the difference?
Does whole life insurance really offer all of the above benefits?
Let’s take a look and find out.
What is whole life insurance?
Whole life insurance is a permanent life insurance policy that provides a death benefit, builds cash value on a tax deferred basis, allows you to borrow from the life insurance policy, and some whole life insurance policies may pay dividends from time to time.
Whole Life Insurance Death Benefit
The death benefit on a whole life insurance policy tends to be a level death benefit policy. With some whole life insurance policies that pay dividends, you may be able to select an option that will use your dividends to buy additional life insurance for you. This is called Paid Up Additions.
Are There Different Types of Whole Life Insurance Policies?
Yes there are many types of whole life insurance policies such as:
- Participating Whole Life Insurance – pays dividends
- Non-Participating Whole Life Insurance – does not pay dividends
- Limited Pay Whole Life Insurance
- Single Premium Whole Life Insurance
Whole Life Insurance Cash Values
Over the course of time, a whole life insurance policy will build cash values. If your whole life insurance policy builds enough cash value, you may be able to borrow cash from the policy via policy loans.
It is important to note that your beneficiaries DO NOT receive the death benefit and the cash value from your life insurance policy. If you die, your beneficiaries would only receive the death benefit, not the cash value.
Typically the death benefit on a whole life insurance policy is reduced by the amount of any outstanding policy loans you have.
Cash values grow tax deferred within a whole life insurance policy and you may be able to access cash values at a later time via policy loans.
If you surrender your life insurance policy, you would receive the cash surrender value of the life insurance policy if there is one.
What is a Whole Life Insurance Dividend?
A whole life insurance policy dividend is a return of your premium…basically you paid too much and the life insurance company is returning your excess premium to you in the form of a dividend. Since a dividend is typically considered to be a return of your money, it does not create a taxable event…in most cases.
Life insurance dividends can be paid back to you in cash, dividends can be used to reduce your life insurance premiums, or dividends can be used to buy Paid Up Additions on your whole life insurance policy.
Dividend Tip – When considering a participating whole life insurance with dividends, look at the history of that life insurance company’s dividend performance…are the illustrated dividends in line with past performance?
Whole Life Insurance – Things to Consider
Whole life insurance premiums tend to be expensive. It is important to get the right amount of life insurance for your situation.
Can you afford a whole life insurance premium year after year?
If the answer is yes, whole life insurance may be a great option for you.
If the answer is no, maybe you need to look at other options such as term life insurance or universal life insurance.
Whole Life Insurance Tip – If whole life insurance appeals to you, it may make sense to buy some whole life and some term life insurance to get the right amount of life insurance at a reasonable price.
If you consider this option, look for term life insurance with a good conversion option. This will allow you to convert your term life insurance into whole life insurance at a later time if you like.
There are many types of life insurance products, and over 100 life insurance companies available in the United States….We have selected about 40 of the most competitive life insurance companies in the U.S. to make sure that you receive quotes from the life insurance companies that will best fit your needs, circumstances, budget and more.
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Michael J Horbal is the owner of LifeInsuranceAdvisors.com, an independent life insurance agency specializing in high risk life insurance. Since 1998, Michael has helped thousands of consumers with their personal, business, and estate planning life insurance needs. Check out our life insurance blog for detailed articles to help you.