Life insurance coverage can be used to provide income for families in the event of the death of a wage earner or to simply to cover mortgage payments, living expenses, and final expenses like medical bills and funeral expenses. Most people do not realize that some types of life insurance also offer investment and saving options that can be used in financial or tax planning.
In the following article, we will discuss the pros and cons of 3 major types of policy coverage: term, whole, and universal life insurance.
Term Life Insurance
Term life insurance is the least expensive type of coverage. It is considered pure insurance and does not offer any savings or investment features. In standard term life policies, the policyholder pays a fixed premium for a pre-set period of time, which can be as little as three months or as long as 30 years.
If the insured person dies within the policy period, the death benefit is paid to the beneficiary of the policy. If the person does not die within the policy term, the policy expires and the insurance company retains the payments.
Types of Term Life Insurance
Some term life coverage offer return of premiums with interest if the insured survives expiration. These policies are more expensive than standard ones and the interest rate on the accrued premiums are not guaranteed.
There are also increasing and decreasing term life insurance policies. Increasing term life starts with a lower premium and death benefit which increases over the policy term. However, decreasing term life insurance, which is usually used to cover your mortgage, declines in premiums and protection as you pay off your principle.
Other term life policies are available to meet the individual needs of different consumers.
Term Life Pros and Cons
The advantages of term life coverage are its low initial rates and flexibility. Since it is temporary, term must be renewed or replaced when the policy expires and rates for new policies can be substantially higher than the initial coverage. It has been estimated that over a lifetime, the cost of term life is about the same as that of whole life insurance, but term life has no cash value and no tax advantages. Choosing between term vs. whole life coverage depends on your individual needs and budget.
Whole Life Insurance
Standard whole life insurance has fixed monthly premiums and a fixed death benefit, which extends over the insured person’s lifetime. There is also a savings feature called the cash value. Part of the premiums are returned to the insured in the form of the cash value, which can be redeemed or used as security for low interest loans during the insured person’s lifetime. Interest and dividends paid on the cash value of policies are tax deferred until the income is removed from the policy.
Consumers can opt for different payment options when buying whole life insurance. Some policies have limited payments where the policyholder pays premiums for a set amount of time, perhaps 20 years, and the policy is paid up and remains in effect until the insured person dies or the cash value is redeemed.
Single payment life insurance is paid in a lump sum at the policy’s inception. The policy is permanent and the cash value can be used for low interest loans with no income tax liability. Compare whole life insurance quotes to review the different types of permanent policies.
Whole Life Pros and Cons
The major disadvantage of whole life insurance is that the initial rates are considerably higher than those of a term life policy with the same death benefit. Whole life accrues a cash value over time and money earned on your policy equity is tax deferred until it is withdrawn.
Permanent coverage never has to be renewed or replaced and the rates are fixed and never increase. The cash value can be used as security for low interest loans with no requirement for repayment.
Universal Life Insurance
Like whole life, universal life insurance offers permanent coverage as well. It is less expensive than whole life insurance and has a minimum and maximum premium rather than fixed payments.
The cash value of the policy is invested in financial instruments like stocks and bonds and the value of the death benefit is tied to the success of the investments. If the cash value reaches zero due to investment failures or negative returns, the coverage is cancelled. You will need to compare term vs. universal life insurance to see which policy offers the best protection for your needs.
Some universal life policies guarantee a minimum rate of return on the cash value of the policy, making them nearly as secure as whole life coverage. Variable universal life policies allow policyholders to make investment decisions by choosing investments from a menu, such as select mutual funds and ETFs, provided by the insurer.
Universal coverage has the same tax advantages as whole life and may have a higher rate of return if the stock market performs well, but policyholders also face the risk of losses.
Universal Life Pros and Cons
The flexible premiums of universal life allow policyholders to select the amount they can pay each month. If a policyholder is unable to make a payment, the premium can be withdrawn from the cash value.
Universal insurance is permanent and the policy has a cash value with the advantage of tax deferred income. Unlike whole life protection, most universal policies do not guarantee a return on cash value and the policyholder may lose part or all of the cash value through investment failures.
Each of the three categories of life insurance has many policy options that allow individuals to customize their coverage to meet individual needs and budgets. Consumers may also choose to buy more than one kind of life policy in order to maximize the advantages of each to meet their needs and goals. Supplementing a whole or universal policy with term life insurance helps policyholders get the benefits of cash value with the flexibility to adjust the death benefit as circumstances change.
Everyone needs life insurance coverage, although coverage may need tweaking over the course of a lifetime. While permanent policies offer you the opportunity to use some of the cash value while living, term life insurance gives individuals the flexibility to diversify their coverage as financial obligations change. Consumers should educate themselves on all the benefits of life insurance before making a purchase.