In recent years, Americans have experienced economic challenges. While some are maxing out credit cards and cashing in 401(k)s, many overlook life insurance as a potential source for emergency funds. And, few are aware of the investment features some policies offer.
When thinking about life insurance, you should know there are two main types: term and permanent. A term life insurance policy pays if the insured dies during the “term” of the policy. Permanent life insurance, the type of policy that offers investment features, combines the death benefit coverage of a term policy with an investment component that can build cash value over time. Some permanent policies also include provisions for policyholders to access money immediately for any reason.
Permanent Life Insurance Options
Unlike term insurance, all permanent policies remain in place as long as the premium is paid. They also all have a cash value component that increases over time and allows the owner to borrow against that cash value. There are four types of permanent life insurance:
- Whole Life Insurance
- Offers a fixed premium for the duration of the policy, guaranteed annual cash value growth and a guaranteed death benefit.
- Does not provide investment flexibility and, once established, you are not allowed to change the policy coverage.
- Universal Life Insurance
- Allows the policyholder to determine the amount and timing of premium payments (within certain limits) and to adjust coverage levels as needs change.
- Includes guaranteed annual cash value growth but no investment flexibility.
- Variable Life Insurance
- Allows allocation of investment funds across stocks, bonds or money market accounts with different levels of risk and growth potential.
- A minimum cash value is not guaranteed because of market fluctuation, and coverage amounts cannot be changed.
- Exposes the policyholder to greater market risk, but has the potential for greater long term returns compared to whole or universal life insurance policies.
- Variable Universal Life Insurance
- Combination of variable and universal life insurance.
- Offers the most flexibility (compared to other permanent life insurance options) with the ability to vary premium payments, investments and coverage amounts.
- Allows investment in a variety of market products chosen by the policyholder, and may allow policyholders to make tax-free transfers among investments.
- Exposes the policyholder to greater market risk than whole or universal life policies.
There is more to think about than the death benefit when selecting life insurance. If you choose permanent life insurance, be sure to consult a licensed investment or tax advisor for guidance on which policy best fits your risk tolerance and investment objectives.
A number of factors may affect life insurance premiums:
- The age you purchase your policy. The older you are, the more expensive the premiums.
- Your overall health. Life insurance companies typically ask you about your medical history, request access to medical records and even obtain blood and urine samples for testing.
- Pre-existing and/or chronic health problems, such as diabetes, heart disease, cancer or sexually transmitted diseases may prevent you from getting life insurance or place you in a high-risk pool at greater cost.
- Poor health habits, such as smoking and excessive drinking. Be aware that insurance companies may look back and consider these behaviors for the past five years.
- Engaging in dangerous hobbies, such as skydiving, skiing or rock climbing
- Your driving record, in terms of accidents, DWI/DUI citations, claims and tickets. The better your driving record, the better rates you’ll receive for your life insurance.
- Your geographic area. Life insurance companies have access to regional data that document mortality rates and life expectancy, and they use that data to calculate the rates they offer.
Some of these factors are in your control. Others are a function of your genetics, occupation or location. Either way, it’s important for you to be educated on these issues so that you can make the best insurance decisions to fit your life.
Read the fine print. Look carefully at the annuity you are considering. Check the interest rate, find out how quickly the annuity will grow in value and when you can reap its benefits. Some annuity rates can change over time, so make sure that you understand the difference between the guaranteed minimum rate, the current rate and any first-year or so called “bonus” rates. Also make sure you know whether the annuity is tax-deferred, meaning that you will not have to pay taxes until you receive payments from the annuity.
Try before you buy. Many states have “free look” laws that give you a set number of days — typically 30 to 60 days — to review an annuity contract after you buy it. You can back out of the contract at any time within the “free-look” period; a refund is required to be issued within an allotted time period, as stated in your contract. Take advantage of this review period to make sure you understand what you are purchasing.
Don’t get caught by surrender charges. Withdrawing your money from an annuity before it has matured might subject you to fees, known as surrender charges, as well as other administrative fees and acquisition costs. There could be high penalties if you make a withdrawal prior to the maturation date provided in the policy. Be sure you are aware of these provisions so that you don’t inadvertently incur such costs.
Don’t judge a financial professional by title alone. Designations such as “certified senior adviser,” “certified retirement financial adviser,” “chartered senior financial planner” and “certified financial gerontologist,” might seem to imply expertise in providing investment advice to senior citizens. However, such titles don’t always guarantee that the financial professional actually has specialized knowledge or education in that area. Ask them what the designations mean to them and what they had to do to earn them. Ask them if they have ever lost or given up a designation and, if so, why.
Ask for help. Many people have been harmed by annuity scams. If you are concerned that you might have been misled by a fake company or fraudulently sold a misrepresented product, call your state insurance department to get assistance and/or to file a complaint. You can file a complaint directly with your state insurance department via the NAIC’s Web site at www.naic.org/cis/fileComplaintMap.do.
Check the insurance company’s credit rating. Through resources such as Standard & Poor’s, A.M. Best Co. or Moody’s Investors Services, you can see whether the annuity company you are considering has a solid credit rating. An “A+++” or “AAA” rating is a sign of strong financial stability.
Check the NAIC’s Consumer Information Source (CIS). The NAIC provides a database for consumers to research an insurance company’s financial information and complaint data. The information in the CIS is supplied voluntarily by state insurance departments. Not all states provide the data, nor are all companies listed within the directory.
Get more life insurance tips specific to your life stage.
Who Needs Life Insurance?
Your need for life insurance varies with your age and responsibilities. It is a very important part of financial planning. There are several reasons to purchase life insurance. You may need to replace income that would be lost with the death of a wage earner. You may want to make sure your dependents do not incur significant debt when you die. Life insurance may allow them to keep assets versus selling them to pay outstanding bills or taxes.
Consumers should consider the following factors when purchasing life insurance:
- Medical expenses previous to death, burial costs and estate taxes;
- Support while remaining family members try to secure employment;
- Continued monthly bills and expenses, day-care costs, college tuition and retirement.
What is the Right Kind of Life Insurance?
All policies are not the same. Some give coverage for your lifetime and other cover you for a specific number of years. Some build up cash values and others do not. Some policies combine different kinds of insurance, and others let you change from one kind of insurance to another. Some policies may offer other benefits while you are still living. There are two basic types of life insurance: term insurance and permanent insurance.
Term insurance generally has lower premiums in the early years, but does not build up cash values that you can use in the future. You may combine cash value life insurance with term insurance for the period of your greatest need for life insurance to replace income.
Term insurance covers you for a term of one or more years. It pays a death benefit only if you die in that term. Term insurance generally offers the largest insurance protection for your premium dollar. It generally does not build up cash value.
You can renew most term insurance policies for one or more terms, even if your health has changed. Each time you renew the policy for a new term, premiums may be higher. Ask what the premiums will be if you continue to renew the policy. Also ask if you will lose the right to renew the policy at a certain age. For a higher premium, some companies will give you the right to keep the policy in force for a guaranteed period at the same price each year. At the end of that time you may need to pass a physical examination to continue coverage, and premiums may increase. You may be able to trade many term insurance policies for a cash value policy during a conversion period even if you are not in good health. Premiums for the new policy will be higher than you have been paying for the term insurance.
Permanent insurance (such as universal life, variable universal life and whole life) provides long-term financial protection. These policies include both a death benefit and, in some cases, cash savings. Because of the savings element, premiums tend to be higher.
How Much Life Insurance Do I Need?
Ask yourself the following questions:
- How much of the family income do I provide?
- If I were to die, how would my survivors, especially my children, get by?
- Does anyone else depend on me financially, such as a parent, grandparent, brother or sister?
- Do I have children for whom I would like to set aside money to finish their education in the event of my death?
- How will my family pay final expenses and repay debts after my death?
- Do I have family members or organizations to whom I would like to leave money?
- Will there be estate taxes to pay after my death?
- How will inflation affect future needs?
Some insurance experts suggest that you purchase five to eight times your current income. However, it is better to go through the above questions to figure a more accurate amount.
Tips on Buying Life Insurance
- Make sure you feel confident in the insurance agent and company.
- Decide how much you need, for how long, and what you can afford to pay.
- Learn what kinds of policies will provide what you need and pick the one that is best for you.
- Do not sign an application until you review it carefully to be sure the answers are complete and accurate.
- Do not buy life insurance unless you intend to stick with your plan. It may be very costly if you quit during the early years of the policy.
- When you buy a policy, make the check payable to the company, not the agent.
When I bought my life insurance policy, the agent said it would be "paid up" after ten years, but it's been that long and I'm still getting bills. Why?
Your contract (insurance policy) may provide for guaranteed interest rates and/or dividends the insurance company will pay on your premiums. But your premiums must make very high earnings before they will "pay up" your policy. The company must stand behind items that are guaranteed in the contract. Promises of "paid up" life insurance are illegal when based on non-guaranteed values. If you have documentation of the agent promising this, your state insurance department may be able to help. Documentation would include any writing containing the promise -- even an informal, handwritten note or a similar notation by agent.
Who can take out a policy on my life?
Only someone who has an "insurable interest" can purchase an insurance policy on your life. That means a stranger cannot buy a policy to insure your life. People with an insurable interest generally include members of your immediate family. In some circumstances your employer or business partner might also have an insurable interest.
Insurable interest may also be proper for institutions or people who become your major creditors.
Must my beneficiary have an insurable interest?
No. If you buy a policy on your own life, you become the owner of the policy. As the owner, you can name anyone as beneficiary, even a stranger!
What about companies that advertise "no physical exam?"
The insurance may be more expensive than if the company required a physical. Although there is no physical, you will probably have to answer a few, broad health questions on your application.
Some life insurance ads claim "you can not be turned down." What's the catch?
Such ads are for "guaranteed issue" policies that ask no health history questions. The company knows it is taking a risk because people with bad health could buy their policies. The company balances the risk by charging higher premiums or by limiting the amount of insurance you can buy. The premiums can be almost as much as the insurance. After a few years you could pay more to the insurance company than it will have to pay to your beneficiary. Such policies may offer only the return of your premiums if you die within the first couple of years after you buy the policy.
Why is term life often called "temporary" insurance?
Insurance agents sometimes refer to term insurance as "temporary" because the term policy lasts only for a specific period. It is probably no more "temporary" than your auto or homeowner insurance. Just like term, those types of policies provide coverage for a specific period of time, and must be renewed when that period ends.
Why are some insurance agents reluctant to sell term insurance?
An agent may believe term is risky, but only because you could have a hard time buying a policy in the future if your health deteriorates or you cannot afford the higher premiums. Commissions could also be a reason for an agent who discourages term. The agent often makes less money for selling term than for other forms of life insurance.
What do I get when I buy term insurance?
You have bought and received the company's guarantee that if you die during the term of the policy, it will pay a death benefit to your beneficiary.
Does that mean I've wasted my money if I don't die?
No more than you have wasted money by buying car insurance but never having an accident. You've purchased peace of mind. With term life insurance, if you die during the term, you know the company will pay your beneficiaries.
An insurance agent has suggested I switch term companies every couple of years to take advantage of the company's promotional rates in the first couple of years. Anything wrong with that?
Nothing wrong, but there is always a risk when you switch polices that you could be subject to a new contestability period. You start a new, 2-year contestability period anytime you switch . If you die during that 2-year period, the insurance company can (and probably will) investigate the statements you made on your application . If you've given inaccurate or incomplete answers, the company may (and probably will) refuse to pay the death benefit.
I understand my permanent policy would be "fully paid up" at age 65. What does that mean?
"Fully paid up" means just that. You have made enough premium payments to cover the cost of insurance for the rest of your life.
What happens to the cash value after the policy is fully paid up?
The company plans to use the cash value to pay premiums until you die. If you take cash value out, there may not be enough to pay premiums. The company could require you to resume paying premiums, or reduce the amount of the death benefit to an amount that the remaining cash value will support.
I had a policy that was paid up; now I'm told I don't. What can I do?
You may have signed papers that permitted the cash value of your paid up policy to be used to pay for another, larger policy. If you're not sure or can't remember, call the insurance company.
What is a "participating" policy?
That is a policy that may pay you dividends. You have a chance to "participate" in the company's earnings. A life insurance dividend is actually a refund of part of your premium. When a company collects more money in premiums than it needs to pay death claims and maintain the insurance pool for future claims, the company may pay dividends at the end of that year.
An insurance agent has suggested that I buy term instead of whole life. Does it makesense to buy term and invest the difference?
"Buy term and invest the difference" has been a popular sales slogan for term life. The pitch compares term, the least expensive form of life insurance, with other kinds of life insurance.
- $100,000 death benefit at age 35
- Annual whole life premium: $1,800
- Annual renewable term premium: $250
- Difference: $1,550
What are your choices?
- Buy whole life. The "difference" is used to keep your premiums lower than the actual cost of insurance as you get older.
- Buy term. You keep the difference.
In addition, make sure you consider the following:
- As you get older your term premiums will increase to keep up with the cost of insurance;
- If you invested the difference, you could use your investment to pay the higher cost of insurance;
- If you spent the difference you will have to dip into other savings to pay higher premiums; and
- If your health deteriorates you may not be able to buy a new policy
For 10 years I paid the insurance company $1,000 every year. That's $10,000! But when I cashed in the policy they sent me only $5,800. Where did the rest of my money go?
The rest of the money paid for insurance. You were entitled to only the cash surrender value — that is, the amount you had paid to "pre-fund" insurance in your old age. The amount would have been even less if you had borrowed money that had not yet been repaid.
How much cash value is in my policy?
Read your policy. It has a table of cash values that should provide the answer. Call your agent if you are still not sure of the cash value amount.
What happens to the cash value in my policy when I die?
When you die, the insurance company will pay the death benefit. No matter how much cash value you may have had in the policy the moment before you died, your beneficiaries can collect no more than the stated death benefit. Any loans you have not repaid (plus interest) will be subtracted from the death benefit.
The result: your beneficiary could wind up with less than the face amount of the policy.
The exception: some whole life policies pay both the death benefit and the cash value when you die.
Review Your Insurance Needs
Talk to an insurance agent. He or she can help you evaluate your insurance needs and give you information about available policies.
Decide How Much Coverage You Need
How much of the family income do you provide? Does anyone else depend on you financially? How will your family pay final expenses and repay debts after your death? Based on the answers to these questions, decide how much coverage you need, for how long and what you can afford to pay. You want to make sure that you buy enough life insurance to cover the financial effects of an unexpected or untimely death.
Assess Your Current Life Insurance Policy
If you already have a life insurance policy, do not cancel it until you have received the new one. You then have a minimum period to review your new policy and decide if it is what you want. Keep in mind that you may not have to cancel your current policy. You may be able to change your policy to get the coverage or benefits you want now.
Compare The Different Kinds of Insurance Policies
There are two basic types of life insurance: term insurance and cash value insurance. Term insurance generally has lower premiums in the early years, but does not build up cash values that you can use in the future. Cash value life insurance may be one of several types: whole life, universal life and variable life. Your choice should be based on your needs now and in the future and what you can afford.
Be Sure You Can Afford the Premium Payments
Before purchasing a life insurance policy, be sure that you can handle the premium payments. Can you afford the initial premium? If the premium increases later, will you still be able to afford it?
Have an Insurance Agent Help You Evaluate the Future of Your Policy
How quickly does the cash value grow? Some policies have low cash values in the early years that build quickly later on. Other policies have a more level cash value build-up. Ask your agent for a year-to-year display of values and benefits.
Keep Your Current Policy
It is important that you do not drop one policy and buy another without a thorough study of the new policy and the one you have now. Replacing your insurance policy may be costly.
Understand Renewal Policies
You can renew most term insurance policies for one or more terms even if your health has changed. Each time you renew the policy for a new term, premiums may be higher. Ask what the premiums will be if you continue to renew the policy. Also ask if you will lose the right to renew the policy at a certain age.
Read Your Policy Carefully
Do premiums or benefits vary from year to year? How much do the benefits build up in the policy? What part of the premiums or benefits is not guaranteed? What is the effect of interest on money paid and received at different times on the policy? These are all questions that you should be able to answer by reading your policy thoroughly. Your agent can help you understand things that are unclear.
Review Your Life Insurance Program Every Few Years
How will inflation affect your future needs? Do you need more insurance when your family size increases? Review your policy with your agent every few years to keep up with changes in your income and needs.