Let's Talk Life Insurance
When it comes to life insurance, there are a few different choices: Whole life. Variable universal life. Term. What do they really mean? And is one better than the other? It depends.
All life insurance policies have two things in common: They guarantee that they will pay a death benefit to the designated beneficiary after the insured dies (although the guarantee can be waived if the death is a suicide occurring within two years of the policy purchase). All require you to make recurring payments (sometimes referred to as premiums) to keep the policy active, or in force. Beyond those basics, the differences are plentiful.
Some life insurance coverage is permanent; some is not. Permanent life insurance is designed to protect you for your entire life, not just a portion, or "term," of it, and it can become an important element in your retirement planning. Whole life insurance is the most common form of permanent life insurance.
Whole life policies accumulate something called cash value. How does that work?
The insurance company directs some of your premium payments into a side, or reserve, account and invests those dollars, typically in a more conservative way. The return on those investments influences the growth of the cash value, which builds up according to a formula set by the insurer.
A whole life policy's cash value grows tax deferred.
After a while, you are able to borrow against the built-up cash value in the policy. You are also allowed to cancel the policy and receive a surrender value. What's the catch? Premiums on whole life policies are usually higher than premiums on term life policies, and they can rise with time. Beneficiaries might receive only a death benefit and not the policy's cash value when a whole life policyholder dies.
Universal life insurance is whole life insurance with a key difference.
Like whole life policies, universal life policies build cash value with deferred taxes, but there is the opportunity to eventually pay the premiums from the policy's investment portion.
Month by month, some of the premium collected on your universal life policy gets credited to the cash reserve of the policy. At some point, you may elect to pay premiums from the cash reserve, so the policy essentially begins to pay for itself. If all goes as planned, a universal life policy may have a lower net cost than a whole life policy. However, if the investments chosen by the insurer underperform severely, there could be an issue with the payment of the policy. If the cash reserves dwindle away the policy could end up being accidentally canceled if the premiums are unpaid.
What about variable life (VL) and variable universal life (VUL) policies?
VL policies are whole life or universal life policies with an investment component that is riskier. In both VL and VUL policies, you may direct percentages of the cash reserve into investment subaccounts that are managed by the insurer. Assets allocated to the subaccounts may be put into equity investments of your choice as well as fixed-income investments. If you choose to direct these funds to equity investments, you and the insurer assume greater risk in exchange for the possibility of greater reward. The performance of the subaccounts cannot be guaranteed. Due to this risk exposure, a VUL policy usually has a higher annual cost than a comparable UL policy.
Stock market performance could heavily affect the performance of the subaccounts and thus the policy premiums. A bull market may mean better growth for the policy's cash value and lower premiums. A bear market may mean reduced cash value and higher monthly payments to keep the policy active. In the worst-case scenario, the cash value plummets, the insurer raises the premiums to provide the guaranteed death benefit, the premiums become too expensive for you to pay, and the policy lapses.
Term life insurance is life insurance that you "rent" rather than own.
Term insurance provides coverage for a set period, usually 10 to 30 years. Should you die within that covered period, your beneficiary will receive a death benefit. Typically, the premium payments and death benefit on a term policy are fixed from the beginning, and the premiums are significantly lower than those of permanent life insurance policies. When the term of coverage comes to an end, you may be offered the option to renew the coverage for another term or to convert the policy to a form of permanent life insurance.
Term life is inexpensive, which is appealing, but the trade-off comes when the initial term is over. Just as you cannot build up home equity by renting a house, you cannot build up cash value by renting life insurance. When the term of coverage is over, you usually walk away with nothing for the premiums you have paid.
Do you need a life insurance policy in retirement?
This is a difficult question, and the answer varies depending on your unique situation. One school of thought says no, you don't. The kids are grown, and the need to financially protect the household against the loss of a breadwinner has passed. If you are considering dropping your coverage for either or both of those reasons, you may also want to consider the reasons to retain, obtain, or convert a life insurance policy after your retirement. Take these factors into account and have a talk with your trusted financial advisor before making a decision.
Could you make use of the cash value in your policy?
If you have a whole life policy, you might want to utilize the cash value in response to certain retirement needs. If you need extended care, for example, you could explore converting the accumulated cash in your whole life policy into a new policy with an extended care rider. This might even be accomplished without any tax consequences. If you find that you need additional income, many insurers will let you surrender a whole life policy you have held for some years and arrange an income contract with the cash value. You can access the money, tax free, as long as the amount that is withdrawn is less than what you paid into the policy. Remember that withdrawing money or taking a loan against a policy's cash value naturally reduces the policy's death benefit.
Do you receive a "single-life" pension?
Maybe you have a pension-like income you receive each month or quarter from a former employer or through a private income contract with an insurer. If you are married and there is no joint-and-survivor option on your pension, that income stream will dry up if you pass away before your spouse. If you die early in your retirement, this could present your spouse with a serious financial dilemma. If your spouse risks finding themselves in such a situation, consider finding a life insurance policy with a monthly premium equivalent to the difference in the amount of income your household would get from a joint-and-survivor pension as opposed to a single-life pension.
Will your estate be taxed?
Should the value of your estate end up surpassing federal or state estate tax thresholds, then life insurance proceeds could help pay the resulting taxes and prevent the need for your heirs to liquidate assets to cover a tax bill.
Are you carrying a mortgage?
If you borrowed to purchase your home or have refinanced and are carrying a mortgage, a life insurance policy may make sense. It could potentially relieve your heirs from shouldering some of or all of that debt if you pass away with the mortgage still outstanding.
Do you have your burial paid for?
The death benefit of your life insurance policy could partly or fully pay for the costs of your funeral or memorial service. In fact, some people buy small life insurance policies later in life to prepare for this expense. Alternatively, you may seek to renew or upgrade your existing term coverage for permanent life insurance to assist your loved ones with this cost.
Which coverage is right for you?
Many factors come into play when you are deciding which type of life insurance will best suit your needs. The easiest thing to do is to speak with a qualified insurance professional who can help you examine these factors so you can determine which type of coverage you should have.