Deciding to purchase a life insurance policy can be confusing and overwhelming, given the various policy types and seemingly endless design alternatives. With the right guidance, however, the process can be manageable, the needs of your beneficiaries will be addressed, and you can feel confident in your choice. A rational decision process begins with understanding the types of life insurance policies, how they are alike, and, importantly, how they differ.
UNDERSTANDING THE TYPES OF LIFE INSURANCE
There are two main categories of life insurance policies: term life insurance and permanent life insurance.
Term Insurance: Term insurance is the simplest and most basic form of life insurance. Term insurance policies, as the name suggests, provide life insurance coverage for a specific time. For example, the policy could cover a single year (yearly renewable term) or extend for a period of years, such as 10, or 20, or to age 65. The policy owner pays the premiums, and the life insurance company pays the death benefit claim if the insured dies during the policy term. Term life insurance policies do not have an associated cash value and are a “pay-as-you-go” form of pure death benefit coverage. If the sole purpose of the insurance is temporary death benefit coverage, term insurance is quite cost-effective; however, once the term ends, coverages cease unless the policy owner elects to pay additional premiums at a significantly increased rate.
Permanent Insurance: Permanent life insurance is intended to provide death benefit coverage through the insured’s life expectancy (or up to age 120). This type of insurance also has a cash value component that is intended to sustain the policy after the premium paying period in addition to providing an opportunity to withdraw or borrow against the policy’s cash value. Permanent life insurance is further classified as either Whole Life or Universal Life, and there are variations within each of those classifications. Typically, these policies require more premium than term policies as well as more detailed policy management.
POLICY TYPE OVERVIEW
Whole Life Insurance: Many whole life policies require premiums for the duration of the policy (life expectancy). However, recently some life insurance companies have structured these policies with premiums over a shorter duration. Crediting on the policy’s cash values comes in the form of a dividend declared annually by the insurance carrier. While these policy types (due to their guaranteed death benefits) can have a higher expense structure, they are typically quite low on the risk spectrum.
Universal Life Insurance: These policy types combine a flexible premium schedule with various crediting methods.
- Fixed Universal Life: This policy is credited with a fixed rate of interest determined periodically by the life insurance company. This rate is influenced by general interest rates and offers relatively low risk for the policyholder.
- Variable Universal Life: Policy values are invested in “separate accounts” similar to mutual funds. The policy is credited based on the performance of the separate account, which frequently is made up of stocks, bonds, and other securities. When the separate accounts perform well, policy crediting can be very appealing. However, there is an unlimited downside if the separate accounts decrease in value, making these policies the riskiest of the universal life alternatives.
- Indexed Universal Life: The crediting on an indexed universal life insurance policy is tied to the change in a major market index, like the S&P 500, but subject to limits. These limits are the minimum crediting rate (referred to as a floor), the maximum rate (referred to as a cap), and the participation rate (the percentage extent to which the policy is credited the change in the index). The floor is typically no less than 0%, meaning that there will never be any negative returns, unlike variable universal life insurance policies. The trade-off for this protection is sacrificing the gains that exceed the cap. Depending upon the risk tolerance of the policy owner, this trade-off could make sense by lowering risk while providing for appealing cash value growth.
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TriscendNP is dedicated to offering objective guidance and unrivaled plan administration services so that your life insurance policies and related plans stay on track and your objectives are achieved. Let us guide you and your organization through a disciplined decision-making process. Contact us for a plan analysis today!