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Investment Planning |
How to Choose a Life Insurance Policy
Life insurance provides payment to a survivor upon a death and it can be a critical component of your overall financial plan. Understanding the types of life insurance available to you will help you to choose the best coverage and the most cost-effective policy for your particular situation. Because purchasing an insurance policy is an important decision that will financially affect you during the years you pay premiums and will later affect your survivors, you should discuss your particular situation with a professional advisor.
Term insurance is purchased to cover insurance needs for a specific, finite period of time, usually from one to 20 years. Advantages of term insurance include a lower premium for each dollar of coverage, a lower initial outlay, and a guaranteed maximum premium for the term purchased.
Disadvantages of term insurance include an increasing premium as the policyholder ages, no build-up of cash value, and the risk that the policy may not be renewable at the end of the term. However, you may purchase a guaranteed renewal feature. Term insurance is a great, low-cost way to provide security in the event of an unexpected death.
Whole life insurance provides a level premium, guaranteed renewable cash value life insurance coverage for the lifetime of the insured person. The advantages of whole life include: a level premium, so you'll know when you purchase the policy exactly how much the insurance will cost each year; a policy that is guaranteed to be in force as long as you pay the premiums; and a build-up of cash value.
The whole life policy's cash value is the amount that has accumulated in the policyholder's account. It grows tax-deferred at a minimum guaranteed rate. It is not subject to fluctuations of the stock market and may be used as a forced savings vehicle. Whole life policies contain several inherent disadvantages, including a higher initial premium outlay and a lack of flexibility in the early years of a contract.
Universal life insurance is similar to whole life insurance in that it accumulates a cash value that is tax-deferred. The advantages of a universal life policy include:
- Flexible premiums
- Adjustable death benefits
- Potentially lower premiums than other types of insurance
Disadvantages of universal life include:
- An uncertain future yield on the policy's cash value
- No forced savings plan available because premium payments are flexible
- Coverage may not be competitive
- The policy may lapse if the premium level you've chosen is not adequately covered by the interest credited
Variable life insurance combines the protection of a life insurance policy with a growth and/or income producing investment. The variable life insurance policyholder may invest in a vehicle similar to a mutual fund. The advantages of this include a potentially higher yield and a fixed premium payment. The disadvantages of variable life insurance include a premium generally higher than a whole life policy and forgoing a stated cash value for the potential of a higher cash value and death benefit that may not be realized.
A variable universal life insurance policy includes flexible premiums, mutual fund-like investments for the contracts' cash value, and a variable death benefit. A disadvantage of variable universal life insurance is that all investment risk lies with the policyholder. The policyholder chooses the investment vehicle in which his cash value will be placed. Choosing an investment with high returns results in a larger cash value than an investment that performs poorly.
For all variable life insurance products, you pay a fee for an insurance wrapper around a mutual fund. Why not just invest directly in a mutual fund?
Tips Disclaimer
These tips contain information that may change over time as a result of new tax legislation. Although we make efforts to keep this information current, you should check with your tax advisor before taking action based upon any information contained in these tips.