When you’re shopping for a new car, what kind do you plan to buy? It’s an analogy which rings true in choosing from the many types of life insurance in order to get the cheapest life insurance rates you can while still meeting your needs. Think about it like this:
You probably don’t arrive at your local car dealer and just point to a car with a nice color and sign immediately. In fact, you probably discover you need a vehicle for one reason or another before you even think about which brand you’re deciding on. If you need a work truck, a small two-seater car is not going to work. If you need to log a lot of miles without breaking the bank, a large lifted truck won’t be necessary either.
Shopping for life insurance is really not all that different, but there are several life insurance types to choose from.
Placing your need first and matching the life insurance policy type to that need is the most effective way of choosing, and it might end up saving you a lot of premium dollars in the long run. We’ll begin by discussing possible needs, and we’ll explain the different types of life insurance that match. This will also help you narrow down the best life insurance companies to place your business with as well.
What Do You Really Need?
These three questions might seem basic, but they are really the only questions that you need to answer to narrow your focus on what type of life insurance is most appropriate:
- What do you actually need to cover?
- How long do you need to cover it?
- Are you healthy?
Like in our example above, what do you need the car for? Defining the kind of mileage you need, the interior space, and the hauling capacity up front is going to greatly affect the type of motor vehicle is best. With life insurance, defining whether you need to replace income, cover a mortgage, or collaterally assign for a loan will all force you to adjust your possible policy type to make sure you serve the right purpose, and pay the right premium.
The duration is important, too. Are you leasing a car or buying? Maybe you’re fine with paying lower payments each month to have the car for a short duration. Or maybe you want a brand new car and you want to take advantage of the benefits that come with it, like a 100,000 mile warranty. Again, life insurance is identical. Do you need a short term policy or a lifetime policy to help settle your estate no matter what age you pass?
And finally, your health matters for choosing a policy type, too. Just because you think you want that car, doesn’t mean you can have it. You need to be approved first.
The Different Types of Life Insurance
Although it’s an industry nearly two centuries old, more changes in the evolution of life insurance have happened in the past few decades than the rest of time combined. With each evolution, new policy types are becoming available to suit different needs and markets. It’s also increasingly difficult to tell the difference between a few, as the benefits and composition of the policy themselves are quite similar on the outside; looking at the details, you’ll see they contrast quite a bit.
Term Life Insurance
This life insurance type is how you’re going to get the most bang for your buck if you need a larger coverage amount. Term life is what you see advertised on television for the insanely low prices to cover you for a quarter million dollars, and companies are able to offer these prices because, statistically, only 1% of them will ever pay out. This is a result of consumers changing policies, dropping policies, converting them or simply out living them.
The way it works is a carrier offering coverage for a level duration at a level premium. The duration can be as little as a year or as many as 40, but whichever you choose, it’s the time period in which the issuer cannot change your premiums so long as you maintain your premiums and keep your policy in force (current).
Term policies can have additional riders attached, which add different benefits, and they can be converted to more permanent policies, too. The only real limitations with term are the ability to qualify, max coverage based on need (called insurable interest), and their unavoidable end date.
Universal Life Insurance
Let’s say you love the idea of a level death benefit and a level premium, but you need something longer than the standard term life insurance policy. What should you do?
The most cost effective way is going to be utilizing a universal life policy, which accomplishes exactly that: a permanent death benefit for a level premium. They are perhaps the most flexible of all life insurance types, allowing for consumers to make unequal payments at times, adjust their coverage to whatever age they intend, from 85 to 121 based on need, and even grow cash value.
Universal life insurance policies, especially when they have built-in guarantees, are considered some of the best life insurance plans for seniors who are looking to get the most bang for their buck.
It should be mentioned that accessing cash value from a strict universal life insurance contract by of loan or withdrawal can greatly impact the latter years of the policy, even diminishing certain guarantees if the policy isn’t funded as originally intended. They are also sensitive to interest rates, which is why many policies started in the late 80’s and early 90’s are beginning to implode on their owners in today’s low interest environment.
Whole Life Insurance
Whole life operates, more or less, the opposite way when compared to term life.
A true whole life policy does not end at any age, and will, quite literally, cover you for life no matter how old you get. They also grow cash value, unlike term, which is both tax deferred and accessible tax free by loan. The death benefit amount can also grow, although this is not always the case depending on the company it is issued from, as well as when it was issued. If over-funded for cash growth, an increasing death benefit is a must in order to keep the policy from becoming a modified endowment contract.
Many different riders are available with whole life policies, some of which are different than what is available for term. There also may be a dividend payment through the policy to the consumer, if applicable. The company you choose will be the determining factor in how the cash growth accumulates, with different guarantees from issuer to issuer; dividends are never guaranteed.
Indexed Universal Life Insurance
One of the newer types of life insurance available in the marketplace today is indexed universal life. It is one of the more complicated types of life insurance policies, and should only be purchased if the contract is completely understood by the consumer.
Indexed universal life is like a universal life in regards to lifelong death benefit and cash growth, but ties cash growth to stock market indexes in an attempt to leverage market gains for additional growth. It has been under fire, and remains so, because of it’s ties to the markets without requiring a registered representative to place the policy for their client. Part of the reason it has become popular, however, is by minimizing the downside risks of the market and allowing the policy owner to participate in growth years only.
Variable Universal Life Insurance
Variable universal life policies are similar to indexed, but they are investing in mutual funds as opposed to indices.
As noted a moment ago, a registered representative is required to make the sale of this type because of its investment and policy risks. Just like all other cash value types, the growth within the policy is tax deferred as well as tax free when accessed by loans because premium dollars are post-tax. This makes the variable life contract especially intriguing for some, as it allows market participation without the taxation and holding requirements of a standard IRA or 401(k).
Survivorship Life Insurance
The survivorship policy is one of the most unique types of policies because it is bound to two lives, not one.
Survivorship policies can be either universal or whole, but always permanent in nature. The death benefit only pays after both insureds are deceased, giving way to its nickname, second-to-die life insurance. Because the death benefit is delayed until both have passed, the cost per thousand of coverage is lower since the insurance company is able to mitigate its risk. This should only be used in certain circumstances, outlined below.
Accidental Life Insurance
Accidental, also called accidental death and dismemberment (AD&D), is a type of life insurance where a death benefit is only paid when the insured passes due to proven accident. Health related deaths do not pay a benefit. Most companies require a claim to be submitted within a certain time period, such as 90 days, to verify the death was indeed a result of a an accident.
Because they only pay out in more rare circumstances, the cost per thousand is significantly less and underwriting requirements are far simpler.
Life Insurance Policy Types By Need
There are many different reasons why someone considers buying life insurance. It’s not one of those purchases you wake up one day thinking, “Boy, I’d love to get some life insurance today!”
A few circumstances usually get a persons mind thinking about it. A life altering event, a mandatory request for coverage, or a big purchase using debt for leverage are all possible situations, and each is a good reason to begin looking at a life insurance policy. But coming to the conclusion why you need it is not always so clearly written. Here are some things it covers best:
- Income Replacement to Dependents
- Long Term Debt Obligations
- Burial Expenses
- Buy / Sell Agreements (a type of Key Man policy)
- Small Business Loan Collateral
- Business Continuation Plans
- Advanced Estate Plans
- Charitable Giving
- Divorce Decree Requirements
- and more…
Let’s start from the top and discuss each one in brevity.
Type: Term or Return of Premium Term
Typically one of the largest needs to cover is your replacement of income to your dependents. If you weren’t here to work and create an income, how much money would your family or dependents require immediately to continue their lifestyle as if you were still here?
This is covering human capital, or your future ability to earn. For younger folks, they have more working years, so they tend to have a higher earning potential loss when passing early as compared to their older counterparts who are nearing retirement. The general rule of thumb for replacing income is 7-12 years of your current income. Each person is going to have a different need here, and insurance will also have different caps at what they’ll offer based on your age and income; the younger the applicant, the higher the factor allowed.
Even those who don’t work may want to consider something for this category. As an example, if you are a stay-at-home mom, replacing what you do with the children at home to allow your spouse to continue working would cost a lot. While you may not be getting paid by an employer, you add significant value to the household, and there would be financial reason to have insurance on your life should something happen to you.
A return of premium term life insurance does allow you to recoup your payments, as long as you pay to the end. If you don’t, however, you may lose your paid premiums.
Type: Term / Universal
The second most common need to cover with a life insurance policy is for debts you owe. There are certain types of debts which would go away at your passing, called non-transferable debts, but most debts will be paid by your estate or left to a secondary person, like a spouse.
A mortgage is the best example. If you currently are paying a mortgage down, how much would it cost to either pay the remainder off completely or at least leave enough aside to make payments for some time. Either train of thought is okay, but consider taxes, insurance or other things which might change over time.
If you have a debt which will definitely end at some point, matching the term duration to this could save you money. If you purchased your home with a 15-year mortgage as opposed to a 30-year, you could cut premiums drastically by only getting a 15-year policy.
Type: Universal / Whole
Most people consider the cost of a funeral or cremation, which is great, but they tend to forget other end-of-life expenses. Burial life insurance, or final expense, covers this.
The typical funeral may cost only $7,000-10,000, but there are other bills, too, like possible lawyers fees, medical bills left behind, and more. Unfortunately, medical bills can get extremely expensive when someone is declared terminal or fights a chronic illness, so trying to account for those bills is a necessity, although difficult. If nothing else, leave enough to aid your dependents in financing the debt for a certain period.
Buy / Sell Agreements
Type: Term / Universal
A buy / sell agreement is one where two or more business partners are planning for what to do with the business should one or more of the partners pass before the business is handed down or dissolved properly. In this matter, it helps to prevent the surviving partner to suddenly be in business with the his partners spouse or heirs.
Choosing the policy type here is usually dependent on the nature of the business, the business model, and how the company is already structured and laid out by law. It is recommended you work with both your insurance agent and a legal professional to make certain it is written and setup properly. The way the policy is paid for can also differ from a traditional individual policy.
The vast majority of all small business are under funded or funded by OPM (other people’s money). In the case of borrowing, especially in the form of an SBA loan, you are probably required by the lending institution to have life insurance in place, with the death benefit earmarked to the institution, to be approved.
Term is the best solution for a couple of reasons. First, your loan terms will have an end date, so matching your term life insurance policy duration to the length of the loan may drastically decrease premiums; not many lending institutions will offer ultra long loans, depending on the business industry. Second, it’s a wise idea to keep your business insurance separate from your personal, so try not to bundle them together. But in some instances, it might be cheaper to buy life insurance at a certain death benefit amount for price breaks and list the amount above the principal loan amount to family.
Finally, consider a no exam life insurance policy if your loan date is fast approaching and you’re not yet approved for coverage.
Type: Universal / Whole
As a business grows, the owner or owners may, at some point, decide they want to continue the business after they pass, whether it be to family members or not. In order to do this, life insurance can be used as a tool to shift ownership and assets and give immediate funds distribution where necessary.
Because there may be an undetermined amount of time in which the current owner will stay as a partner or shareholder, it is best to use permanent coverage to avoid any chances of lapsing where the life insurance wouldn’t have the opportunity to take effect as planned. This is more of an advanced planning situation, so you may need to consider discussing all possibilities with legal and financial professionals.
Type: Universal / Whole
One of the best uses for life insurance is estate planning. Because there are sizable assets, there is no better way to leverage dollars within an estate to become much, much greater at the time of a settling estate.
Estate planning is a complex planning procedure, but in essence, a large estate will be subject to estate taxes if it is large enough. Exemptions have a ceiling, so using life insurance to offset those taxes allows for more liquidity and leaner distribution methods to heirs.
The whole idea of estate planning is attempting to pass on as much value on to the next generation as possible, so it makes a perfect fit that life insurance is, dollar for dollar, the premiere way to turn 1 dollar into many at death.
Type: Universal / Whole
Charitable giving plans could act similar to estate, except that the leverage is being used to take a small amount now and compound it into something greater as a final gift to a charitable organization, society, fraternity or university.
The basic idea is to forego giving annually now, and put those dollars into life insurance as premiums to magnify the giving power when you pass. Not only will the policy be able to give a greater amount than you put in, but it is passed on without taxation as a life insurance policy death benefit is tax free by nature.
Consider using a legal or tax professional to make sure the arrangement is set up properly so any deductions can still be taken.
By law, some spouses may be required to own life insurance for the benefit of the other after a divorce has been settled.
This can be for a couple reasons, but the most common are to protect child support and alimony payments where necessary. If the spouse who owes child support were to pass, the other spouse would be left without the future payments. But, if life insurance is in place, it could provide immediate cash to replace the future cash flows which would have been received has the spouse lived and continued paying.
Remember, the key to choosing from the many types of life insurance is to choose by need. Whatever it may be, match the death benefit amount, duration and beneficiary to serve the right purpose and you’ll save time and hassle of browsing through policies which are least favorable.