TERM LIFE INSURANCE
As the name implies, this is life insurance for a term, or a set number of years. Most term policies offer a level premium guaranteed for 10/15/20/25 or 30 years. At the end of the term the policy either ends or the premium jumps so high that virtually every policyholder lets the policy lapse. Think of term life insurance as similar to automobile insurance. It covers you in case of an unexpected collision (premature death). If you don’t have a collision (you don’t die during the term period) no benefit is paid out.
Term life insurance will almost always give one the most death benefit for the lowest cost. It is best suited for temporary life insurance needs such as:
- Family protection while children are young and dependent
- Covering a mortgage or other debt
- Funding a business buy/sell agreement
- The cost of replacing a key employee
PERMANENT LIFE INSURANCE
A permanent life insurance policy is designed to last for a lifetime. This can be accomplished through a number of various types of permanent life insurance contracts. Permanent life insurance is best suited for:
- Estate liquidity needs, such as inheritance tax
- Permanent business buy/sell arrangements
- Inheritance equalization
- Charitable Legacy
- Extinguishing long term debt
Here are some of the most popular types of permanent life insurance:
WHOLE LIFE INSURANCE
Whole life policies typically have a guaranteed lifetime premium that must be paid for the life of the policy. Part of the premium goes into a cash value account within the policy. The cash value belongs to the policy owner and can be borrowed (at interest) while the policy remains in force. If the policy is cancelled then the cash value is paid to the policy owner. Many whole life policies are designed to endow, i.e., have the cash value equal the original death benefit, at the insured’s age 100. This “classic” whole life contract is designed as a self completing sinking fund, in that the fund which will equal 100% of the original death benefit at age 100 will pay that same 100% whenever death occurs.
Many whole life policies are “participating” which means the company plans to declare and pay a dividend to the policy owner depending on the financial results of the company. Dividends are, in essence, a return of excess premium. Dividends are not guaranteed to be paid. Dividends, when paid, can be taken in cash, used to reduce premium, or used to buy more insurance within the policy.
UNIVERSAL LIFE INSURANCE
Like whole life insurance, universal life insurance is designed to last a lifetime, and part of the premium goes into a cash value account. While whole life insurance is somewhat rigid in its structure, universal life insurance promotes flexibility. Universal life insurance allows the policy owner to fund the policy in a manner which best suits the needs of the policy owner and beneficiaries. While a whole life insurance contract requires premiums be paid each year, universal life insurance allows the policy owner to fund the policy with a planned premium that can be changed or even stopped based on cash value returns and life expectancy anticipation. As long as the cost of insurance (COI) is deducted from the policy values each month, the full death benefit remains in effect. Universal life insurance is a very cost efficient way to purchase permanent death benefit but it does put more potential responsibility on the policy owner to understand and manage the policy as compared to whole life insurance.
Recently, carriers have created universal life insurance with a no lapse guarantee (NLG) premium. This means that as long as the NLG premium is paid the policy remains in full effect beyond age 100. The policy owner still enjoys the premium payment flexibility that universal life insurance contains. NLG universal life insurance tends to have very little or no cash value build up, but it does give solid lifetime premium guarantees with the flexibility to lower or eliminate premium payments in reaction to life circumstances such as a determination that the insured’s life expectancy will not be to age 100 or beyond. NLG universal life insurance is a very cost efficient way to guarantee a lifetime death benefit without overpaying the insurance company.
WHOLE LIFE OR UNIVERSAL LIFE VARIATIONS
A Variable contract allows the cash value to be invested in mutual funds to attain a potentially higher return than a declared carrier return. This type of contract is considered an equity investment and falls under investing regulations.
Similar concept to variable but the cash value may only be invested in index funds (like S&P 500). There is usually a cap, or maximum return that will be credited, but also a floor, or minimum, return credited. The policy will not necessarily capture the market high but will not incur a negative return.
Both Variable and Index life are used primarily as a tax deferred investment vehicle in addition to death benefit protection.