Life insurance is worth taking the time to understand. Not only can Life Insurance provide peace of mind to you and your family by providing a death benefit in case you die, but you can also use your life insurance while you’re alive. Good Life insurance lets you grow your money safely and access your money to take advantage of good opportunities that would pass you by if you put your money in other financial plans.
All life insurance policies provide a death benefit to your family, if you’re still covered at the time you die. Almost everyone knows that.
But many people don’t know that Life insurance, when used correctly, can also benefit you while you’re still alive. This life insurance 101 guide can help you understand the benefits of life insurance and how to determine what type of life insurance is right for you. This first part of life insurance 101 will focus on the different types of life insurance.
Whole life insurance contracts (the oldest type of Paid-up permanent insurance) are designed around the entire life of the insured. These policies provide the basic life insurance benefit, death benefit, but they can also provide life benefits which can be used while you’re still alive. They do this by building up cash value inside the policy via the paid up insurance portion of the contract which can be purchased directly from premiums paid, or with participating whole life policies, with the dividends returned to the policy owner from excess profits of the company.
Cash value grows tax-deferred inside whole life policies and as the policy holder you may “borrow against the cash accumulation fund without being taxed.”[ii] You may also surrender paid up insurance by requesting a withdrawal from the cash value.
Anytime a loan or withdrawal is taken you should understand the tax ramifications and the effects such an action will produce on the death benefit, future policy dividends and interest that may be charged. Because of the death benefit and the life benefits, Whole life insurance can be used to cover the basic life insurance needs but also to help you grow your wealth and take advantage of good financial opportunities during your lifetime.
(Also see: What Is Participating Whole Life Insurance?)
The other basic kind of life insurance is term insurance.
Term insurance is another type of basic life insurance.
Term insurance is purchased to provide coverage for a specific period of time rather than for a “whole life.” Some term policies have level fixed premiums that can last between 10 and 30 years. This allows the policy owner to pay a fixed annual premium for whatever fixed period the policy contract stipulates. Other term insurance policies have annual-renewable premiums which are adjusted annually. “As you get older, premiums steadily increase.”[iii] If you use term insurance, it’s important to keep your coverage current, so your family can receive the death benefit, when you die.
There are other insurance policies sold in today’s marketplace but they are what you might call hybrids of the two basic life insurance types discussed above and various investment strategies.
Universal Life Insurance (UL) is a hybrid of term insurance and a “money market-type investment”.[iv] Within the concept of universal life, there are a couple of variations.
“Investment returns are variable and are adjusted on a monthly basis.”[v]
Variable Life (VL) is a type of permanent life insurance but is also “generally considered the most expensive type of cash-value insurance”[vi] available. Payments are “determined by the performance of the underlying investment chosen by the policyholder.”[vii] Returns are not guaranteed and these accounts are very often accompanied by higher fees. The greater the investment yield the higher the death benefit can become and most VL’s provide a minimum death benefit regardless of investment performance.
Variable Universal Life (VUL) is another type of permanent life insurance. The cash value can be invested in what are called separate accounts which are “similar to mutual funds”.[viii]
Indexed Universal Life (IUL) is a relatively new type of permanent life insurance which offers a “guaranteed fixed rate of interest and interest based on the performance of an outside index such as the S & P 500.”[ix] Like a typical universal policy, IUL policies direct all premiums paid to be applied to a fixed account which earns a rate of interest. The interest rate is not fixed but typically provides a minimum rate as well as a capped rate. The policy owner can decide upon a percentage of what is held in the fixed account to be transferred to an index account. The index account will earn interest equal to the index growth rate.
VL, VUL and IUL policy contracts contain fees and expenses besides the cost of insurance, surrender fees, and other charges and fees which can dramatically impact the policy values as well as taxes. Therefore, consulting with your financial professional/insurance agent and tax preparer is highly recommended as you make any decision about your life insurance coverage.
This is a service we provide for you. As financial professionals we consult with our clients on the right type, the best design and the most efficient use of life insurance products which best fit their specific needs and long term goals. We specialize in designing policies that build cash value quickly because we know that time is of the essence when you are growing your wealth.
To Learn more about life insurance, read the next installments in the Understanding Life Insurance series.
[i] Life Insurance – Money 101, Lesson 20, CNN Money
[v] Universal Life Insurance, Investopedia.com
[vi] Variable Life Insurance, Investopedia.com
[vii] Variable Life, Investorwords.com
[viii] Variable Universal Life Insurance, Wikipedia.org
[ix] Indexed Universal Life, Harford Investor
Note: Loans and withdrawals from life insurance can cause adverse tax consequences, penalties and may cause a policy to lapse. Insurance products are backed by the claims paying ability of the issuing insurance company and are not FDIC insured. Life Benefits, its agents, and representatives are not authorized to give legal or tax advice. Read Full Disclaimer