Life insurance can be one of the more confusing financial products out there. Many of our clients are often befuddled by what their choices are. Most people follow the recommendation of their insurance agent to determine what best suits their needs. This is fine, typically, because your insurance agent will no doubt know more than you, and is usually in a better position to match your needs to the appropriate insurance vehicle. But wouldn’t it be nice to at least know the basics? Well, here they are.
Start with the 1,000 foot view. All life insurance falls in one of two categories: term insurance or cash value. Most people are very familiar with term. Term means you pay a premium that covers you for a certain period of time. If you die during that period your beneficiary collects. If you don’t die during that period you allow the policy to lapse or you renew it.
Term life insurance further breaks down into annual renewable or level. With annual renewable your premium increases each year because as you get older you are more statistically likely to die. Level term insurance covers you for a period of years (e.g. 10, 15, or 20). The longer the term period the higher your premium will be.
Cash value life insurance is nothing more than term life insurance with a savings feature. In addition to the term premium, you give the insurance company extra money to invest for you. Here are a few of the more popular cash value life insurance products:
- Whole Life- You commit to a fixed premium (term charge + savings feature). The savings feature is invested in real estate, bonds, and perhaps stocks. You receive a guaranteed rate of return, usually 3%.
- Universal Life- You pay flexible premiums. You can vary the amount you contribute to the savings program. Your savings are invested in interest sensitive investments (certificates of deposit, commercial paper, bonds).
- Variable Life- The savings are invested in mutual funds. You make the decision in which to invest in (stock funds, bond funds, money market funds, guaranteed interest rate contracts).
- Survivorship Life- Also known as second-to-die life insurance. The idea is that the policy death benefit becomes available when you need it to pay estate taxes after the second spouse dies. The odds of the insurance company having to pay a claim early are very low. Hence, mortality charges for this type of insurance are fairly low.
So there you go!