A great article by: Jeremy Vohwinkle
Navigating the life insurance landscape can be tricky. You are sure to encounter a number of different policies and terms such as whole life, term life, cash value, variable life, and much more. How can you make sense of all the different types of policies and know that you’re making the best choice? Here’s a quick breakdown of the most common types of insurance policies and the pros and cons of each.
Term Life Insurance
Term life is exactly what it sounds like. You purchase life insurance for a specific term, or set amount of time. You pay premiums for the entire length of the term and once the term is up, your death benefit is gone. Term life does not have a cash value component so your entire premium is simply used to keep the policy active. Once the term is up, you stop paying premiums and the policy expires. This is what makes term life one of the most inexpensive life insurance policies.
But even term life is broken down into a few different categories:
• Level Term – Your premium and death benefit remains the same for the entire length of the term, whether that is 10, 20, or even 30 years.
• Annual Renewable Term – The death benefit remains unchanged throughout the term, but the contract renews annually, usually with an increase in premium each year. Initially, premiums may be less than in a level term policy, but over time it can become more expensive.
• Decreasing Term – Here, the death benefit decreases each year while the premium remains the same. The policy ends when the death benefit reaches zero.
Advantages of Term Life Insurance Term life policies are usually far less expensive than whole, universal, or variable life insurance. Term life also has a very specific coverage period—typically in terms of 10, 15, 20, 25, and 30 years. This allows you to only buy as much coverage as you need. For example, if you’re only concerned about life insurance while you have dependents at home or a mortgage to pay, you can plan out how long and how much coverage you need.
Disadvantages of Term Life There is no cash value component of the policy. Your premiums strictly go towards the policy and do not earn interest or otherwise accumulate. And having a specific term can also be a drawback. If you purchase a 20-year term policy and after 20 years decide you’d like to extend your coverage, you may need to undergo proof of insurability and could be denied additional coverage or need to renew at a significantly higher premium.
Universal life insurance builds on term life and adds a cash component. Here, instead of just selecting a specific term and putting 100% of your premium towards the policy, part of your premium will actually go into a cash account in the policy. This cash account earns interest and accumulates tax-deferred.
Advantages of Universal Life Universal life insurance provides additional flexibility. Because it has a cash component you could actually temporarily stop making premium payments as long as the cash value can cover the cost of insurance. In addition, you may also be able to increase or decrease the death benefit over time. Also, you can usually borrow against the policy in the form of a loan.
Disadvantages of Universal Life Universal life is more expensive than term life. While some of that added cost will be going into the account in the form of building cash value, the rates you earn on that money may not be the best going rates. This is why many financial professionals recommend buying term and investing the difference. This allows you to still purchase a death benefit while having the flexibility to invest the difference anywhere you choose.
Variable Universal Life Insurance
Variable life insurance is very similar to universal life with one major difference. With this type of policy you aren’t earning a specific rate of interest in a cash-value fund, but instead you can invest this portion in a variety of different investments like mutual funds. So, you get much more control and can choose where to invest the cash-value portion.
Advantages of Variable Life You’re still guaranteed the minimum death benefit as long as you keep up with the minimum premium. You also have the flexibility to invest the cash-value portion in a variety of investment vehicles. If you make wise investment decisions you can take advantage of significant tax-deferred earnings on those investments.
Disadvantages of Variable Life By investing part of your policy in possibly risky investments, if the market turns south and you lose a lot of money, you’re putting your policy in jeopardy. A significant drop in account value could force you to pay additional premiums just to keep the contract in force. In addition, the expenses associated with the investments in variable universal life may be significantly higher than you might pay elsewhere.
Whole Life Insurance
As the name implies, whole life is meant to insure someone for their whole life. Like universal life, whole life has a cash-value component. In most cases, in a whole life policy the premium and death benefit are fixed.
Advantages of Whole Life There are no surprises with whole life. You have a guaranteed premium, interest rate, and death benefit for the life of the policy. The cash value also grows tax-deferred and also typically allows for withdrawals and loans against the policy.
Disadvantages of Whole Life Whole life is generally more expensive than both term and universal policies. This is largely due to the added guarantees that come with whole life. Also keep in mind that the policy is not flexible. If you determine you want more coverage or would like to increase or decrease your premium, which probably isn’t an option. Finally, the interest earned on the cash-value account may be less than you could obtain elsewhere.
Choose Your Life Insurance Carefully
As you can see, there are a number of options available and there isn’t a single right answer for everyone and every situation. If you take the time to learn what each type of policy offers you can be sure to get an insurance policy that’s right for you and not just what someone is trying to sell you.