Life Insurance Basics
Life insurance is one of the most important financial purchases you can make. In the event of a tragedy, life insurance proceeds can help you pay bills, continue a family business, finance your child’s education, protect your spouse’s retirement plans and much more. If a wage earner passes away, a family could be devastated financially without life insurance.
WHAT IS LIFE INSURANCE? A life insurance policy is a contract with an insurance company. In exchange for premiums (payments), the insurance company provides a lump-sum payment, known as a death benefit, to beneficiaries in the event of the insured’s death. This benefit is typically tax free to the beneficiaries and bypasses probate.
TYPES OF LIFE INSURANCE There are many different types of life insurance policies and the type of policy chosen is based on the needs and goals of the owner. Life insurance is broken down into five main types: whole life insurance, term life insurance, guaranteed universal life insurance, variable life insurance and indexed universal life insurance.
1. Whole Life Insurance is a permanent insurance policy that builds cash value based upon a set schedule. The exact cash value of the policy is known for each policy anniversary. If a loan or withdrawal is taken from the policy, the cash value and death benefit will decrease. Whole life insurance policies may also pay dividends which helps to increase the cash value of the policy. This type of policy is best suited for individuals who need permanent insurance coverage and who may want to accumulate tax-deferred savings.
2. Term Life Insurance is the simplest of the life insurance options. It is designed to cover an individual for a pre-defined period of time and it typically only pays out a death benefit to the beneficiary if the owner dies during the term period. Term insurance premium payment amounts may be level or increasing over the term depending on the policy and the premiums are typically lower than other insurance options. This type of policy is typically best suited for those with temporary insurance needs such as paying off a mortgage or protecting a child’s education needs.
3. Universal Life Insurance is a type of permanent life insurance with a savings account element. Universal life insurance provides the contract owner the flexibility to raise or lower premiums, within certain limits. It offers fewer guarantees than whole life insurance because if minimal premium payments are made for too long it can impact cash value growth and the size of the death benefit. Cash value is not guaranteed to grow in a universal life policy (as it is in a whole life policy). This type of policy is best suited for individuals who need a permanent life insurance policy but are not concerned with guarantees offered by whole life.
4. Variable Universal Life Insurance is a permanent insurance policy that builds up cash value. The owner has the flexibility to increase or decrease premium payments. The death benefit will be paid if the insured dies any time if there is sufficient cash value to pay the costs of insurance. The policy allows the owner to invest the cash value in variable subaccounts. The policy value will increase or decrease based on the performance of the subaccounts selected. It is possible for required premiums to increase to keep the policy in force if the underlying investments cause the cash value of the policy to drop below the cost of insurance. This type of policy is best suited for individuals who need permanent insurance coverage but would like to grow and access the cash value of the account through potentially tax-free loans and/or distributions.
5. Indexed Universal Life Insurance is a newer option of life insurance that began in the late 1990s. Indexed universal life insurance is permanent life insurance that may appeal to those who want premium flexibility with the potential for cash value growth and downside risk protection. The key difference with indexed universal life insurance is how cash value accumulation is calculated. Unlike a variable universal life insurance solution, the contract owner is not invested in an individual security. Indexed universal life policies allow the contract owner to allocate all or a part of the cash value to the performance of a broad-based securities index, such as the S&P 500. For an exchange of a cap on returns, the carrier provides guarantees of a 0% return. Like universal life and variable life solutions, clients can add, for an additional cost, a no-lapse guarantee rider to preserve the death benefit regardless of actual cash value accumulation.
Note: Many carriers that offer universal life, indexed universal life and variable life offer a no-lapse guarantee rider. With this feature elected, a contract owner can guarantee receipt of the death benefit; assuming illustrated premiums are paid as illustrated, on-time and no loans are taken on the policy to remain in force for the period illustrated (typically to age 100, 110 or 120).