By Matt Lewis, CLTC®
Life insurance is one of the most versatile financial assets available to us. Few solutions carry as many tax advantages, cover as wide a variety of situations, and come at such a range of costs.
With so many different types of life insurance, finding the most suitable policy takes careful consideration. We can help you find the best possible solution. But before you meet with your financial advisor, having a basic understanding of the different types of life insurance can help.
Life insurance typically falls into three main types: term, universal and whole. Unique needs can sometimes call for a novel application of a particular policy, but each type of life insurance generally correlates to a specific need. Let’s explore each of the three types of life insurance and briefly go over the supplemental utility function of hybrid life insurance.
Term Life Insurance
Term insurance is just as its name suggests: Life insurance you take out over a certain “term” or finite length of time (a 20- or 30-year term, for example). It offers straightforward protection and can be an excellent option for those with temporary financial obligations such as young families or individuals with mortgages. Some key points that consumers should know are:
- Premiums are generally lower compared to other types of life insurance.
- Coverage expires at the end of the term, and there is no cash value accumulation.
- Beneficiaries receive the death benefit if the policyholder passes away during the term.
This type of insurance policy is generally used to secure a high death benefit at a relatively low cost over a finite period of time.
We tend to favor term insurance for two general purposes:
- Income replacement – Should something terrible happen to a family member, the decedent’s income continues to flow to the family from the death benefit paid out by the life insurance company.
- Debt security – A family may want life insurance to secure a mortgage or business partners may want life insurance to secure a loan they are taking for their company.
Overall, term life insurance is a good fit when there is a defined need that will last for a known period of time and costs need to be managed.
Universal Life Insurance
Universal life policies provide a permanent death benefit with a variety of different premium schedules. This type of coverage combines a death benefit with a flexible savings component. Universal Life can be ideal for those seeking a customizable approach to coverage and investment.
Some things about Universal Life Insurance that consumers should consider:
- Flexible premium payments and death benefit adjustments are subject to certain policy terms.
- The potential for cash value growth is generally based on market growth potential and usually tied to a fixed rate of interest or an index like the S&P 500
- The need to monitor policy performance and adjust premiums, if necessary
Like other permanent life insurance policies, universal life offers cash accumulation features, different funding options and premium payment flexibility. Universal life policies can be built to meet those needs, but the most common application is providing the highest permanent death benefit for the lowest cost.
Whole Life Insurance
Sometimes referred to as cash value life insurance, whole life policies provide a permanent death benefit while building cash value inside the policy that can be accessed prior to the death of the insured. Because of the emphasis of a cash value account and other policy features, whole life generally carries the highest premium among the three policies. Some things that consumers should be aware of:
- These policies come with higher premiums compared to term insurance, but the premiums remain level throughout the policy.
- Whole life has a cash value that grows over time and can be accessed or borrowed against when needed.
- This type of insurance comes with a guaranteed death benefit and the potential for dividends from the insurance company.
Whole life is generally used as an accumulation asset – not a primary means of life insurance coverage. Clients can fund a policy, earn a rate of return on their premiums, and later use the cash values as another pool of money. And because it’s life insurance, Congress provides favorable tax treatment to this asset. When coupling the taxation and the returns on the premiums clients pay, this policy can become a compelling option as another account to build up cash.
Variable Life Insurance
Variable life insurance is another form of permanent life insurance. It’s primary differentiator is that it offers investment options within the policy, allowing consumers to allocate premiums to various investment accounts. While it offers potential for higher returns than a universal life or whole life policy, it comes with a greater risk. Consumers should be aware of:
- Investment flexibility and potential for higher cash value growth.
- Investment risk associated with market fluctuations.
- The need for active management and monitoring of investment performance.
Hybrid Life Insurance
Life insurance options have had some innovation over recent years with the addition of hybrid life policies or policies that serve multiple functions – like long-term care and death protection.
When it comes to hybrid life insurance, think of a hybrid vehicle. These cars are partially powered by both a battery and a gasoline engine, giving drivers the dual benefit of getting better miles per gallon and being able to drive longer between charges.
Likewise, hybrid life insurance allows you to integrate the advantages of life insurance – such as the death benefit of a whole life insurance policy – with those of a long-term care insurance policy. Since you are getting “the best of both worlds” the premiums tend to be more expensive than that of a traditional long-term care policy, which is more of a use-it-or-lose-it policy with no death benefit.
Life Insurance Riders
Lastly, it is important to understand the various riders that may be available when you are making a purchasing decision. Life insurance riders are add-ons to a policy that can give extra protection to the policyholder in the event of an unfortunate circumstance, such as death or disability. Some of the most common life insurance riders are:
- Waiver of Premium Rider – This rider waives the amount due for the policy if the policyholder becomes disabled.
- Disability Income Rider – This rider pays the policyholder a percent of the death benefit in the event of disability.
- Accelerated Benefits Rider – This rider allows the insured to request their death benefits early in the case of a terminal illness or if the insured is expected to pass away shortly.
Whether your life insurance needs are fairly simple or you have a more complex situation that requires a customized solution, your financial advisor can help. Set up your complimentary consultation today to find the life insurance coverage that’s right for you and your family.
For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Neither Cetera Advisor Networks LLC nor any of its representatives may give legal or tax advice.
The cost and availability of life insurance depend on factors such as age, health, and the type and amount of insurance purchased. Before implementing a strategy involving life insurance, it would be prudent to make sure that you are insurable by having the policy approved. As with most financial decisions, there are expenses associated with the purchase of life insurance. Policies commonly have mortality and expense charges. In addition, if a policy is surrendered prematurely, there may be surrender charges and income tax implications.
There is a surrender charge imposed generally during the first 5 to 7 years that you own a variable insurance contract. Withdrawals prior to age 59½ may result in a 10% IRS tax penalty, in addition to any ordinary income tax. The guarantee of the contract is backed by the financial strength of the underlying insurance company. Investment sub-account values will fluctuate with changes in market conditions. An investment in a variable insurance product involves investment risk, including possible loss of principal. Variable insurance products are designed for long-term investing. The contract, when redeemed, may be worth more or less than the total amount invested. Variable insurance products are subject to insurance-related charges including mortality and expense charges, administrative fees, and the expenses associated with the underlying sub-accounts. Investors should consider the investment objectives, risks and charges and expenses of the variable contract carefully before investing. The prospectus contains this and other information about the variable insurance product. Contact your financial professional to obtain a prospectus, which should be read carefully before investing or sending money.