Whether you’re single or married, in the event of death, your loved ones could be burden with emotional or financial expenses. Having life insurance coverage could alleviate some of the hardship that a loved one might go through. Which type of life insurance is right for you?
Types of Life Insurance Coverage
1. Term Insurance
Term insurance is as the name says. It’s life insurance that provides protection for a specified number of years. Is it one of the least expensive forms of insurance and recommended for individuals who need protection but have limited cash flow. Term insurance stated period can vary as terms may be 1 year, 5 years, 10 years, 20 years, 30 years. At the end of the term, the insurance policy is either terminated or renewed at a higher premium. Term insurance can be converted to a permanent insurance in order to cover longer term needs.
Term-to-100 Policy – There are term insurance policy that may go to age 100. These policies are often seen as permanent policies but have similar characteristics of term policies. They’re considered one of the most economical ways to cover taxes payable at death. Note that these insurance policies don’t build cash value or pay dividends. They provide a death benefit to age 100 and have a steady premium regardless of changes in age or health.
Renewable Term Insurance – Renewable term insurance policies have a feature that guarantee the right to renew the policy for another term. The renewable term is often for the same duration, without providing proof of insurability. However, keep in mind that at the time of renewal, premiums may increase but they cannot increase because a change of insurability (i.e. health). Renewal rates could be as is or at a renewable term as in the policy.
Convertible Term Insurance – Convertible term insurance is term insurance that allows the policy holder to convert it to a permanent insurance without providing proof of insurability. The features of the policy usually stay the same and the amount of the death benefit may not increase. If an individual wants to make any changes to the policy, such as increase in the death benefit, they have to start a new application. Life insurance companies that offer convertible insurance have their own policies and requirements that must be met such as limit on the time holding the policy, health status and age. These type of insurance contracts are more expensive as it exposes the insurance company to more risk.
Situational Examples of Term Insurance
- Matt recently bought a home with a $500,000 mortgage and 20 year amortization. If he were to pass away, he wants to ensure that his mortgage is paid off for his family
- Denise and Joe wants to ensure that their children’s education is paid off. The children are 5 years old and would be in school until 25.
2. Whole Life Insurance / Permanent Insurance
Whole life insurance is a popular type of permanent insurance. As the name says, it provides protection for the whole life of the insured individual. Whole life insurance is also sometimes referred to as straight life insurance or ordinary life insurance that is guaranteed to remain in effect as long as the premiums are paid. At the time of purchasing a whole life policy, the premiums are determined ahead of time and are not to set increase over the life of the policy. As the death benefit and the premiums are guaranteed not to change over time, the insurance company would bear any consequences if they were not to meet these obligations.
The younger when purchasing whole life insurance the more affordable your premiums will be.
Cash Value
The unique feature of whole life policies is the fact that they provide a cash value. The premiums that a policy holder would pay monthly are invested and the income that gets earned creates a cash value. This cash value can be access and used in several ways which are discussed below. The longer you’ve owned the policy, the larger the cash value is and more options for the individual.
Cash Value Withdrawal – The policy holder withdraw from the accumulated cash value in the policy. This withdrawal would affect the growth of the cash value and reduce any benefit that would be paid. If the withdrawal exceeds the pro-rated adjusted cost base, then a taxable disposition would occur, triggering taxable income.
Cash Value Loan – A policy holder can access the accumulated cash value of the policy in a form of a loan. The loan would be issued by the insurance company and interest will be charged. Rates charged can differ. The policy would continue to grow uninterrupted but if the loan isn’t paid back, it would be deducted from the death benefit, including interest.
**Keep in mind that the cash value can also be used a collateral at third party institutions if needed**
Surrender the Cash Value – The policy owner can surrender or terminate the policy at any time. The individual would be entitled to benefit from the excess premium payments. The surrender can be whole or partial.
Keep in mind that the insurer may charge you surrender charges to cover their administrative costs. The longer the policy is in effect, the lower the surrender charges.
Automatic Premium Loan – Whole life policies have a automatic premium loan feature which is by default. If the policy owner misses their monthly premium, the insurance company would borrow against the cash value in order to prevent the policy from lapsing.
Policy Dividends
Whole life insurance pays out dividends and when the policy owner submits the application, they have to decide on how the dividends should be dealt with. Below are some of the common options that are provided to the policy owner.
- Cash Receipt – The dividend would be paid out to the policy holder every year in cash.
- Premium Reduction – A policy holder can reduce the monthly premium that they pay through their dividends payouts. Consider a policy holder who has an annual premium of $4,000 but is eligible to receive $1,000 in dividends. He can reduce his next year’s annual premium to $3,000.
- Paid-up additions – A policy holder can use the dividends to buy new paid up whole life insurance. This is the most common option that policy holders select.
- Dividends Accumulation – Dividends can be accumulated in an investment account where it earns interest income. The income will be taxed depending if the policy is an exempt policy or non-exempt policy.
- Term Insurance – With the dividends, a policy holder can buy term insurance with no proof of insurability required.
3. Universal Life Insurance
Universal life insurance also known as UL insurance is a type of permanent insurance that provides the most flexibility in terms of setting up the policy. The policy holder can choose the amount, frequency, timing, duration, and investments of the contract.
Premiums paid into a Universal Life Policy go into the investment account, where they earn income and grow tax free. The investment accounts can be broken down into:
Investment Accounts
- Tax Sheltered Investment Account (CSV)
- Daily Interest
- Guaranteed Interest Account
- Index-Linked Funds
- Mutual Funds
Out of this investment account, the insurance company deducts the monthly insurance cost. A policy holder can access their investment account as long as there is enough to cover the monthly premiums. Universal life insurance is suitable for wealthy individuals who have excess cash flow and are seeking alternative investments to grow their assets. Universal life policies offer the potential for tax deferred growth.
4. Joint Life Insurance
Joint life insurance is an insurance policy usually between spouses or business partners. It is less costly to buy joint life insurance policy instead of two separate policy. This type of policy is less costly but the death benefit is usually paid on “first to die”. However, there are insurance companies that provide “last to die” policies for estate planning.
5. Group Life Insurance
Group life insurance is a type of life insurance contract where a single contract covers an entire group of people. The policy owner is usually an employer or an entity such as a union. The policy is issued without medical examination and is set up for the benefit of the employees. Premiums on group life insurance policies are lower than individually owned policies. Group life insurance policies have less features and choices in comparison to the individual life insurance which is why it’s important to review your group insurance.
