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Life insurance is applicable to individuals and families in a wide range of financial situations because it refers to a group of several different products, each of which can be customized with riders (basically, add-ons to the policy). The two primary categories of life insurance policy are term and permanent, with term policies only offering coverage for a fixed period of time, while permanent policies last so long as you continue to pay the premiums.
Any of the policies below might be referred to as “no medical exam”, “simplified issue”, or “guaranteed issue” (as opposed to “fully underwritten” policies). These terms refer to the same products, but indicate that the insurer is willing to charge higher premiums for a shortened underwriting process (which can take several weeks) or lack of a medical exam (which actually tends to take less than an hour and can be scheduled at your home or work). These features sound convenient but, unless you are concerned about being issued coverage due to your health, the cost increases tend to outweigh the reduced hassle.
Term Life Insurance
A term life insurance policy offers coverage for a specified period of time, meaning that if you die during the term of the policy the beneficiary will receive the specified payout (also known as the death benefit or face value of the policy). Term policies are generally the least expensive type of life insurance and term lengths can be for as little as one year, but policies are more commonly offered for 5-year, 10-year, 20-year, and 30-year terms.
Aside from the payout and term length, there are a few ways that term policies differ that are important to understand when choosing the best one to fit your financial situation:
Level & Decreasing Term Life Insurance
While premiums are generally consistent for the term of the policy, level and decreasing term policies differ in their payout structure. As the names imply, decreasing term policies pay a lower death benefit over time, while level term policies maintain the same death benefit for the term of the coverage.
For example, if you purchased a 20-year $500,000 level term policy, should you die at any point during the 20 year term due to a covered event (and have paid all premiums) the beneficiary would receive a $500,000 payout. However, if you purchased a decreasing term policy, the payout would change depending upon how long the coverage was in-force. So if you pass after 10 years, the payout may only be $250,000 (though the decrease in coverage each year isn’t always a direct correlation). To illustrate this example:
|Year||Level Term Death Benefit||Decreasing Term Death Benefit|
This policy can be particularly useful if you have a particular outstanding expense or loan, such as a mortgage loan which would be reduced over time, that your family couldn’t cover payments for without your income.
Convertible Term Life Insurance
A convertible policy is simply a term life insurance policy that can be converted into a permanent life insurance policy without the hassle of a new medical exam or underwriting process. If, for example, you received a significant promotion and raise 5 years after purchasing term coverage, you might want to convert to a permanent life insurance policy to take advantage of the tax benefits and receive dividends.
A term policy being convertible doesn’t increase the cost of a policy and simply offers you more options should your financial situation change later on, so we recommended asking for it when obtaining coverage. Just keep in mind that the conversion period doesn’t last the entire length of the term policy, so you’ll need to check when it closes.
Guaranteed Universal Life Insurance
Guaranteed universal life insurance behaves like a term life insurance policy but extends to cover a nearly-permanent term, offering coverage until age 90, 95, 100, 110 or 121. There’s generally no cash value component as you’d find with permanent policies, meaning it’s less expensive, but this policy offers what is essentially lifetime coverage with level premiums. If you’re considering permanent life insurance, but are wary of the complexity of the policy and not interested in the cash value or investment benefits, guaranteed universal life insurance is a less expensive way to purchase nearly-lifelong coverage.
Renewable Term Life Insurance
Short term life insurance policies, such as those with 1-year or 5-year terms, often have the option of being renewable, meaning that at the end of the term you can purchase the same coverage again without a new application process. This can be useful when you have a known obligation, such as paying your children’s college tuition, but aren’t sure of the exact time period during which take place. If your child stays in college an additional 1-2 years, you can simply renew your policy to have coverage while they complete their education.
While this may sound convenient (have coverage every year without committing to a longer term), if you know that you’re likely to want coverage for a greater length of time, you’re likely to do better by simply purchasing a policy with a longer term. This is because every time you renew, you’re essentially purchasing a new policy that’s priced according to your current age, so the premiums will continue increase.
Permanent Life Insurance
Permanent life insurance covers you for your entire life so long as you continue to pay the premiums, and is a category that encompasses several distinct policies.
These policies all generally have a cash value component, which is essentially the surrender value of the policy (if you give it up before its maturity or your death), and is the primary reason permanent life insurance policies are more expensive than term policies. A policy’s cash value is not added to the death benefit, but can be:
- Borrowed against for expenses (such as college tuition)
- Used to pay premiums
- Withdrawn in certain cases
If you pass away after and have borrowed against the cash value of your policy, the amount borrowed will be deducted from the death benefit.
Whole Life Insurance
Whole life insurance tends to have a guaranteed rate of growth for the cash value component of the policy and often pays annual dividends. Depending on your insurer, you may be able to pay the premiums for a pre-determined number of years, as opposed to paying a premium every year, but the annual premium for that period of time will be higher. For example, if you currently have a high income but low retirement savings, you may choose to pay a larger annual premium for the first 20 years to make sure the policy is paid off then build up your savings, as opposed to paying a lower premium for your entire life.
Universal Life Insurance
Universal life insurance is similar to whole life insurance, but the premiums can be paid on a more flexible basis (overpay when you have money on hand, pay less when you don’t) and cash value growth is not always guaranteed, as it may be tied to an index or simply the insurer’s investment performance. In addition, the policy’s death benefit can be increased or decreased should your financial needs change. So, for example, if you purchased enough coverage to cover one child’s education and later decide to have a second child, you can adjust the face value of your policy to reflect the increased costs. Just keep in mind that increasing the death benefit usually requires additional underwriting and decreasing it may cause you to incur fees.
Variable Life Insurance
Variable life insurance is also similar to whole life insurance but, instead of having a guaranteed rate of growth, the cash value of the policy can be invested in sub-accounts offered by the insurer. Each of these sub-accounts behaves somewhat like a mutual fund, as your money is invested in a specified portfolio and the cash value will increase or decrease in value depending upon how that portfolio performs. Should your investments perform well and the cash value increases, it can be used to pay premiums or purchase additional coverage. However, you take on the risks inherent in investing (meaning you might lose the cash value) and don’t have the full range of investment options which would be offered through a brokerage account or retirement account.
Since the growth of your policy’s cash value is tax-deferred, variable life insurance might be a good consideration if you’ve maxed out your retirement account contributions, have a sizable portfolio of more liquid assets (such as in your brokerage and savings accounts), and are looking for an additional investment vehicle that also offers coverage to your dependents should anything happen to you. However, given the complexity of the policy, the additional costs correlated with permanent life insurance policies, and the potential to lose the entirety of the account’s cash value, it’s not recommended if your primary intent is to provide financial coverage in the case of your death.
Riders are useful as they allow you to tailor your life insurance policy and gain certain benefits that aren’t available with the standard coverage. However, each needs to be evaluated in the context of your financial situation and the policy being purchased, as many will increase your premiums and you want to make sure they pay off in terms of value.
The riders available for a particular policy change by insurer, so if you’d like to customize your coverage using them, you’ll want to check what exactly is available before you purchase the life insurance.
Waiver of Premium Rider
A waiver of premium rider offers the option for you to waive premiums until such time as you’re able to work again if you become permanently disabled, or are unable to work due to a covered illness or injury such as:
- Loss of a limb
- Paralysis (full or partial)
- Spinal trauma
- Loss of vision
While the qualifications of disability to trigger this rider will vary according to insurer, it can be particularly important to making sure your policy doesn’t lapse and your family continues to have financial coverage. This is because, for example, if you lost a leg and were unable to work for several months, but accumulated hefty hospital costs in addition to your normal living expenses, your outstanding financial obligations (such as a mortgage) would still be there.
Terminal Illness & Critical Illness Riders
A terminal illness rider, also known as an accelerated death benefit rider, offers you the option of receiving a percentage of your policy’s payout immediately in the case you’re diagnosed with a terminal illness. While this rider is often made available with little to no increase in premium, this is because the terms may be particularly restricted depending on your insurer. The percentage of the death benefit you can receive is generally less than 50%, what qualifies as a terminal illness varies depending on your policy, and the payout you receive may be deducted with interest from the face value of your policy.
A critical illness rider is similar, but offers the option of taking an early payout if you are diagnosed with a chronic illness that requires intense care over an extended period of time. For example, if you have a stroke and are unable to go to do daily tasks without the assistance of a nurse, you could take a portion of the death benefit early in order to pay for the caretaker costs.
Given there’s no obligation to take the early payout, if this rider is offered at no cost it’s a good option to have available. But if it does increase your premiums, the particular terms need to be evaluated carefully.
Return of Premium Rider
A return of premium rider is particular to term life insurance products as it allows you to recoup a portion (or all) of the premiums paid if you live past the full term. However, depending on the cost, you may do better financially to save and invest the difference (plus the money would be available to you at any time and to your family should you die during the term, instead of locked up in the policy).
As you can see, you could do just as well with a term policy with no return of premium rider than you would if you had to pay $400 more annually for 100% return of premium:
|100% Return of Premium||50% Return of Premium||No Return of Premium|
|Total Premiums Paid (30 years)||$27,000||$21,000||$15,000|
|Invested Capital & Returns||$0||$13,952||$27,904|
|Total Money at End of Term||$27,000||$24,452||$27,904|
The above calculations assume a 30-year term policy and 5% annual return on investment. The premiums listed are just representative and do not reflect actual policy costs.
While it’s difficult for parents to consider the death of a child, it’s important to understand that in the case one of your children passes, it can be incredibly expensive to cover the associated costs, such as their funeral or paying off student loans. For example, the average cost is around $10,000, which many families can’t afford in an emergency situation. A child rider is generally available for term policies and offers a limited amount of coverage (generally less than $50,000) in the case your child does pass, and is available for children under a specified age (generally 20 or 25).