In an effort to provide more content around life insurance (and insurance in general), I wanted to get the help from one of my good friends and he provided. Today’s post is from Chris Huntley, who not only writes about life insurance, helps people get life insurance, but also teaches other agents how to successfully service their clients. He’s one of the best in the industry to provide information, so I’m excited he decided to provide an article on Debt Roundup.
Without further ado, here is how to choose the best types of life insurance for you. Take it away Chris…
Finding the right kind of life insurance for your situation can be a daunting task, and getting the wrong one can cost you dearly.
Here’s a secret.
For many insurance agents, the best type of life insurance is an easy choice.
…it’s the one that makes them the most money.
Because of that, it’s essential that you learn for yourself what’s out there and what’s the best fit for you and your family. After all, you’re the one who has to pay for it.
In this article, I’ll be covering three of the main kinds of life insurance: term, whole life and universal life. We’ll go over the basics of each, as well as the situations where they might be a good fit.
Term life insurance
Term life insurance is the cheapest form of life insurance. The main reason for that is because it only covers you for typically 10 to 30 years, meaning you could outlive it, and there’s no guaranteed payout for the insurance companies like there is with permanent insurance.
Here’s how it works:
- You pick a predefined term for your policy (e.g. 10, 20, 30, or even 40 years)
- The premiums stay level during that term period
- If you pass away during your term, the policy benefit is paid out to your beneficiary
- If you make it to the end of the term and you’re stick kicking, most policies move to an “annual renewable” premium structure, in which your premiums increase annually.
- If you cancel at any time, you don’t get anything in return
It’s as simple as that. Now, there are different kinds of term life insurance, but the most common ones charge the same, fixed premium throughout the life of the policy.
…so what’s the best situation for term life insurance?
Just about every situation.
Term insurance is affordable and it’s effective.
It’s an excellent choice for:
- Replacing lost income
- Covering a student loan, mortgage, or debt
- Insuring a key executive or employee,
- Covering a business loan or buy-sell agreement
- Final expenses (burial, cremation, funeral, etc)
I would not recommend “investing” in permanent life insurance plans.
By spending less on term life insurance, you’ll have more freedom to save for your future.
And by the time you hit 50 or 60 years old and the cost of life insurance starts going through the roof, hopefully you have enough saved up that you don’t need life insurance anymore.
According to life insurance expert Tony Steuer, the biggest drawback of term insurance is “having your insurance terminate before your need terminates.” Because of this, it’s a good idea to have a conversion option on your term policy, in case health issues keep you from re-qualifying for term.
The good news?
Almost all term policies are convertible. (But not all, so be sure to ask your agent!)
Whole life insurance
Now from here on out, things start to get a little more complicated…
Whole life is a form of permanent insurance with no predefined term. In other words, you’re covered for life.
There are two main components of whole life insurance:
- Death benefit – This is a fixed benefit your beneficiary receives when you pass away. This amount is not taxed when it’s paid out.
- Cash value – Part of your premium goes into an interest-bearing account held by the insurance company. It grows tax-deferred over time and you can even take a loan out on it tax-free.
Because of the cash value component, and that fact that it offers lifetime coverage, whole life insurance costs on average 10x-20x as much as term life insurance.
Proponents of whole life justify that extra cost by touting the cash value element, asserting that it grows at a guaranteed rate over time—even when the stock market crashes—and you can borrow against it.
…you can even use it to pay your premiums if you get into a financial bind.
But the vast majority of people don’t need it.
First of all, most people simply don’t keep the coverage.
It’s just not affordable. Where you might pay a few hundred dollars per year for a term policy, you’d pay thousands for the same death benefit with a whole life policy.
It gets worse…
The guaranteed minimum rate you earn on the cash value is typically small (Dave Ramsey estimates the lifetime return on whole life at 2.6%), especially compared to what you could potentially earn if you bought term and invested the difference.
And if you somehow do fall on hard times and don’t have enough cash value to pay the premiums, all that money you put into the policy is gone. As Willy Wonka would say, “You get nothing! You lose!”
…now with all that said, there are a few instances where whole life would be beneficial to someone:
- If someone has maxed out their retirement accounts and is looking for another tax-sheltered way to save for retirement.
- If someone has a very large estate and wants as much as possible to go to their heirs. In this case, they could use the policy to cover estate taxes.
- If someone is a high risk due to a medical condition and can only qualify for a “guaranteed issue” policy, which is based on whole life.
- If someone develops medical problems while on a term life policy, but needs the insurance, so they convert their policy to whole life. Typically, this would be a situation that would prevent them from getting term life again.
- If someone needs a small, “final expense” policy to cover the basic burial expenses (these are usually whole life policies).
According to Dave Ramsey, “Cash value life insurance is one of the worst financial products available.” That’s because the majority of people who buy it don’t need it.
Universal life insurance
Like whole life, universal life is a form of permanent insurance. The two have their differences, though.
…for example, unlike whole life, which locks you in with a high, level premium, universal life allows flexibility in your premiums.
But like whole life, your policy comes with a cash value account, where it grows over time. You can also use your funds to help pay your premiums.
If the cash value account performs poorly, though, the insurance company may ask you to pay a higher premium to keep your coverage.
Those who might be interested in universal life are the same people who might be interested in whole life. That is to say, it’s not for most people. The biggest difference between universal life and whole life is the flexibility in making premium payments.
The biggest drawback to this one is that you have to keep an eye on your cash value account. If it underperforms and hits zero, you could lose your coverage.
…in other words, if you want a set-it-and-forget-it policy, this one isn’t for you.
Best of Both Worlds? “Term-like Universal Life”
Many companies offer universal life insurance plans with guaranteed “no lapse” provisions, guaranteeing the policy won’t lapse, regardless of the cash value, up to a certain age, as long as minimum premiums are paid.
These plans typically have little to no cash value, although because of the guarantee, they continue to offer coverage anyway.
Sometimes these policies are referred to as “guaranteed universal life” policies, and are a terrific lower-cost alternative to whole life or universal life. They act a lot like a term policy, but to age 90, 95, or 100.
The next steps
Trying to decide between these three types of life insurance should be easy for most people. If you’re not experiencing any of the scenarios in which permanent insurance would be a better choice, go with term.
“Consumers should keep in mind the issues they are trying to resolve by purchasing life insurance,” said Rachel Podnos, a financial advisor from Florida in a Nasdaq article. For most people, it’s to replace lost income in case you die. Nothing more.
If you’re not sure, don’t let that uncertainty delay you from getting the coverage you need. Do as much research as you can to find the right policy for you. Do some due diligence to find a trustworthy life insurance agent who can help guide you.
Author Bio: Chris Huntley is president of Huntley Wealth & Insurance Services in San Diego. He also owns eLifeTools, a site dedicated to online marketing for insurance agents. He can be reached on Twitter @mrchrishuntley.