Planning for a person’s own death or incapacitation can often be an uncomfortable and difficult discussion for a person or family to have. It is common for us in the financial planning world to encounter people who are hesitant to make the necessary plans and take the needed steps to account for the possibility that our lives may come to an early and untimely end. Life insurance can be a very important part of a comprehensive financial plan. In the event of a premature death, it can provide financial security for a family, replace a lost income, pay off outstanding debts, or provide a legacy to the named beneficiaries.
There are a number of different types of insurance policies available for someone looking to purchase life insurance. The policies are usually classified as one of two types: term insurance or permanent insurance. Term insurance is insurance that covers a specific length of time- usually 10, 20, or 30 years. Permanent insurance, as the name implies, is insurance that remains in force permanently. Let’s examine these types in greater detail:
Term insurance is life insurance that covers a specific length of time. The length of time is determined when you buy the policy and the coverage is provided a cost that remains in effect for that same period. If you were to pass away during this period, your beneficiary would receive the death benefit. If you do not pass away during this period, the coverage expires and you have the option of simply letting the insurance expire or renewing the coverage for a new term at a rate that is typically higher than when you purchased the initial policy. This type of insurance is typically cheaper than the permanent options, and is often ideal for a person that is looking to have insurance coverage only during a specific time. For example, you might wish to cover only the time where you have young children, or for the length of a specific cost or debt (such as a mortgage), or to replace your income while you are working. In each of these cases, you desire to have the coverage during the period that these factors are relevant, but you don’t mind having the coverage lapse when your children are grown, your mortgage is paid off, or you retire from the workforce and no longer need the insurance.
Permanent insurance is insurance that covers you for as long as you are living, provided that you pay the premiums. Policies typically build a ‘cash value’ inside the policy, which builds up as you pay your premiums over time. Permanent policies can be structured a number of ways:
– Whole life policies are the traditional form of permanent insurance, where in the most basic form the policyholder pays a set premium amount, and the cash value of the policy grows at a set rate.
– Universal life policies were developed to accommodate the desire for flexibility in life insurance. The policyholder has flexibility in the amount and timing of the premium payment and the insurance company pays a fixed rate of interest into the policy account.
– Variable life policies incorporate the stock market into the insurance product. The cash value of the policy is invested in separate accounts that function similar to mutual funds. The rate of return of cash value is then based on the performance of the investments. Unlike other policies that have guaranteed cash value returns, these policies have the potential for losses if the market performs poorly and additional funds may be needed to keep the policy from lapsing. Alternately, if the investments perform well, the returns could significantly outpace the fixed return products.
So which product is the best choice? It is difficult to provide a clear answer to that question without examining each person’s situation individually. Some people would benefit from using the commonly used theory of ‘buying term and investing the difference’ instead of purchasing the costlier permanent insurance products. Others might benefit from the tax-deferred growth of the cash value inside a permanent policy, or from the “forced savings” that comes from making the regular premium payments.
There are numerous rider add-ons and variances on the policy types that we have touched briefly on here, so if you have questions on life insurance or what would fit best for you, be sure to contact your Financial Advisor/Wealth Manager/Insurance Agent to discuss your specific situation. There are a number of great agents available in the Dane County/Greater Madison area to guide you.