Life Insurance 101
James Schofield - May 12, 2023
Here's a quick crash-course in the different types of life insurance and what they are used for.
A Life insurance policy is a contract between the policy owner and an insurance company. The owner makes premium payments, and in exchange, the insurance company provides a tax-free lump-sum payment, the death benefit, to the policy beneficiaries upon the insured's death. Insurance is available as joint or individual protection; for a joint policy, the death benefit can be paid on the first death or the last death.
The amount and type of coverage are based on needs and goals. The cost of life insurance depends on the insured's age, gender, health, medical history, and lifestyle, and premiums can be paid monthly or annually. Beneficiaries can be family members, a business, an estate, or a charity. There are two main types of life insurance: term and permanent. Term life insurance provides protection for a set period, while permanent insurance provides lifetime coverage.
Term Life Insurance
Term life insurance is designed to provide financial protection for a specific period (the term). With traditional term insurance, the premium remains the same for the coverage period selected. After that period, policies may offer continued coverage, but at substantially higher premiums. Term life insurance is generally less expensive than permanent life insurance. Most term policies can be converted to permanent insurance regardless of any changes to the insured's health, occupation, or lifestyle.
Usually, term life insurance proceeds are used to replace lost potential income during working years. You may have basic group life insurance through work, but the amount may not be enough to meet needs, and coverage typically ends when you leave your job. The term policy death benefit provides a safety net for your beneficiaries and can also help ensure the family's financial goals will still be met, goals like paying off a mortgage, keeping a business running, and paying for kids' education.
Permanent Life Insurance
Permanent life insurance provides protection for your entire life, continuing until your death, regardless of what age that might be, as long as you pay your premiums. Permanent life insurance can be important for estate planning when a source of funds is needed to help cover final expenses, offset a large final tax bill, or leave a gift to a charity. There are several types of permanent insurance: Term 100, whole life, and universal life.
For whole life and universal life insurance, clients can accumulate investments inside the policy up to a certain limit, which is called: The Maximum Tax Actuarial Reserve (MTAR limit). The investments inside the policy grow on a tax-sheltered basis policy and can be paid out, along with the face value of the policy, on a tax-free basis at death.
For this coverage, fixed premiums are payable up to age 100, but the benefit lasts a lifetime. Some insurance companies offer reduced-pay periods (limited pay), meaning that you can pay for the lifetime cost of the policy over 10 or 25 years, for example. This can be advantageous for a young working individual who wants to pay the higher premium cost during working years so that when he/she retires, the policy will be paid off, i.e., no further premiums are required, and the policy will remain inforce for life. Sometimes, Term-100 plans offer cash-surrender value, but most companies offer no cash-surrender value with these plans.
Whole Life Insurance
Whole life policies offer level premiums for life with limited-pay options available. Premiums usually are higher (than term or universal coverage) as the policy has a cash value, which generally has at least a guaranteed portion. Whole life insurance can be participating, where policyholders may receive dividends or non-participating where policyholders do not receive dividends, but premiums are generally lower.
For participating policies, dividends can be used to accumulate additional cash values, buy additional life insurance, reduce future premiums, or purchase a one-year term insurance policy.
Universal life insurance
Universal life insurance policies are much like whole life policies, but, unlike whole life insurance, universal life policies are flexible. They may allow clients to raise or lower premium or coverage amounts. As a minimum, the mortality charge must be paid to keep the policy inforce.Also, unlike whole life insurance, universal policy owners choose the specific investment products they want to hold within the universal life policy