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The Ultimate Guide for Choosing the Best Type of Life Insurance Policy

Let’s face it. Shopping for life insurance sucks. Finding a trustworthy source for in-depth life insurance knowledge is a challenging task.    

Even well-respected experts have opposing viewpoints on life insurance. 14 million listeners tune into Dave Ramsey's podcast on personal finance each week. Ed Slott is a respected tax advisor and keynote speaker on tax planning. Both men have decades of experience. Both are also authors of best-selling personal finance books. 

Dave Ramsey fiercely defends that life insurance protection should never be permanent. He believes term insurance is the best type of life insurance, period. Ed Slott believes that permanent life insurance should be the "bedrock of any serious financial plan." He believes permanent life insurance is an attractive asset due to its favorable tax treatment.

Why would two knowledgeable experts have completely opposing viewpoints? Which expert should we listen to? An in-depth Google search often leads to more confusion. You definitely don’t feel like you are receiving the full picture when you speak to a life insurance agent.

Researching life insurance facts should not have to be so tedious and overwhelming. After 13 years in the insurance industry, I decided I had had enough of seeing one-sided arguments. I became fed up with hearing professionals and media preach that only one type of life insurance was best for all. 

This guide provides a balanced perspective of each policy type, so you can make a wise decision. Your specific situation, needs, and goals should dictate what a wise decision is. This guide includes insights from over a decade of industry experience. Reading this guide will give you a clear understanding of your options. You will have the knowledge to secure a policy that is best suited for you today. You will also learn how to position your family for success in the future.

Here is what you are about to learn:

  • The basics of each type of life insurance

  • The advantages and disadvantages of each policy type

  • Who each policy type is most suitable for

  • Unique policy provisions and features to look for to maximize the value of your policy

  • How to create a plan that provides the greatest flexibility in the future

 

Term Insurance

 

Basics of Term Insurance

Term insurance is the most straightforward type of life insurance policy to understand. When setting up a term policy, you select your desired coverage amount and duration. The duration of your coverage will determine when your coverage expires.

Advantages

Term life is the most cost-effective type of life insurance in the marketplace. Most term policies have premiums that will remain the same for the entire term duration. This transparent setup makes term policies predictable and easy to manage. Your beneficiaries will receive the full insurance benefit if you die before your policy expires.

Disadvantages

Although very affordable, over 97% of term life policies end up not paying out a death benefit. According to the statistics, you have a high likelihood of outliving your term policy.

If you decide you want to extend your term coverage, you will need to apply for a new life insurance policy. At this point, you will be applying based on your age and health when submitting your new application. If you are still very healthy, you will still pay higher coverage rates based on your older age. If you are no longer as healthy, your policy may receive a lower health rating or get declined.

Who Term Insurance is Most Suitable For

Term insurance is most suitable for individuals or families with a limited budget. Many families have a hard time finding more money to save. Additionally, young families often need higher life insurance coverage for the following reasons:

  • Higher amounts of debt (student loans, consumer debt, mortgages)

  • More years of income to replace

  • Children are younger

  • Low amount of assets saved

This combination makes term life insurance the easy choice for most younger families.

Term insurance may also be most suitable if you need coverage for a finite period. This assumes you have already accounted for other factors, such as income replacement and education costs. Some examples include protection while paying down your mortgage or business debt. Since you have a clear idea of when you will pay the debt off, you can select an appropriate term duration.

Key Considerations

Convertibility feature

Most term life policies include a conversion feature. The conversion feature allows you to convert your term insurance to permanent insurance. When converting to permanent insurance, you are purchasing a new policy. The key advantage here is you will not have to take a new medical exam. Instead, you will be able to apply the same health rate class from your term policy to your new permanent policy. This can be very impactful if you are no longer as healthy as you were when you started your term policy.

You do not have to convert your entire term to permanent insurance. A partial term conversion may be affordable and make perfect sense.

Although your health rate class remains the same, your age is not locked in for your new policy. You will pay insurance rates based on your age when you convert to a permanent insurance policy. Since insurance costs more as you age, converting at a younger age can help you save on insurance costs.

Make sure your term policy has a conversion feature if you plan to buy permanent insurance in the future. You can ask your insurance agent to run options to convert your term during your annual review. You will be able to weigh costs and benefits to make a wise decision for your family.

You can only exercise your term conversion with the carrier you placed your term policy with. For this reason, you'll want to know if the permanent policies offered are in alignment with your goals. Be clear on when your policy's term conversion period expires, as it varies among carriers.

Unique Policy Features

Some carriers offer innovative features that may be valuable for some policy owners. Be sure to ask your agent about options available to you based on your goals.

A few carriers offer a term policy with return of premium. These policies may cost 20-30% more than a traditional term policy. If you outlive your term policy, you can receive a full refund of all premiums at the end of your term duration.

One carrier offers a policy that allows you to keep coverage beyond the term duration. You will have the option to pay the same premium for a reduced amount of life insurance coverage. If you are no longer as healthy or can't afford a new term policy, this feature can benefit you.

Some carriers even offer term policies with an accelerated death benefit. Qualifying trigger events may include chronic, critical or terminal illness.

Life insurance bands (cheaper cost at certain benefit amounts)

Many life insurance buyers are not aware of face amount bands, also known as premium bands. Face amount or premium bands offer a lower cost for coverage at higher insurance amounts. Although rate bands vary among carriers, a standard rating band may look like this:

Band 1: 100,000-249,999

Band 2: 250,000-499,999

Band 3: 500,000-999,999

Band 4: 1,000,000+

This knowledge will help you get the best value for your life insurance premium dollars.

 

Permanent Insurance

 

Basics of Permanent Insurance

Permanent life insurance protection lasts for your entire life. Unlike term life, permanent insurance policies do not expire. Your death benefit is guaranteed to pay out as long as you pay enough premiums. Since you have lifetime protection, premiums are much higher for permanent policies.

Most permanent life insurance policies have a cash value component. Cash value is the equity you build within your policy during your living years. You can draw money from the policy's cash value while you are still alive. 

Permanent Insurance Policy Types

There are variations of permanent life insurance policies, each having unique features.

This summary covers each permanent insurance policy type, along with its unique features.

Whole life

A whole life policy is generally considered the most secure form of insurance. Whole life policies have more rigid premium payment requirements than universal life policies. As long as scheduled premium payments are paid, the cash value is guaranteed to increase each year. A whole life policy may be most suitable for you if you are seeking the greatest predictability in your future policy values.

Universal life

Universal life policies provide more flexibility in premium payments. These policies offer more transparency around fees and expenses as well.  There is a premium schedule of minimum payments to cover annual insurance costs. Premiums paid above the required amount are added to the cash-value account and earn interest. A universal life policy may be suitable if you are seeking premium flexibility.

The life insurance company determines the interest rate credited to the universal policy. Factors that impact interest rates include expenses, mortality rates, and investment experience. An indexed universal life policy is a variation of a universal life policy. Interest rates credited in these policies are based on annual returns of one or more indices selected. A universal life policy may be suitable if your income fluctuates. Flexibility in your premium payment schedule can be a valuable feature. IUL policies may be suitable for those seeking upside potential from linking cash value returns to a stock market index. It is important to consider other nuances (i.e. cap and participation rates) when buying an IUL policy.

Guaranteed universal life

Guaranteed universal policies work similarly to term insurance policies. Instead of lasting for a specific amount of years, you select an age to have protection through. Policies will remain in force as long as premiums are paid. Since GUL policies have little to no cash value buildup, premiums are much lower than traditional permanent policies. A GUL policy can be suitable if you are looking to make minimal premium payments to have pure protection.

Variable universal life

A variable universal life policy provides the policy owner more control. You can select from a list of sub-accounts (similar to mutual funds) to create a portfolio. You can also adjust investment allocations to align with your investment objectives. Your cash value returns directly correlate to your investment allocations. One key difference is that you risk the potential for loss of cash value in a VUL policy. VUL policies generally have a minimum death benefit guarantee as long as you continue to pay premiums. VUL policies may be suitable for those seeking more control over policy performance, while accepting the accompanying investment risk.

Overfunded permanent policy

An overfunded policy refers to extra premiums paid into a permanent insurance policy. The surplus premiums buy more coverage and increase cash value in the policy. You can choose to overfund either whole life or universal life policies. This can be an attractive strategy if you want the option to withdraw cash from your policy in the future. A knowledgeable agent may be helpful in designing and servicing an overfunded policy.

Advantages of Permanent Insurance Protection

The main advantage of a permanent insurance policy is the security it provides. There is certainty that your life insurance will pay out when you die, not if you die during the term duration. The certainty of a death benefit provides flexibility to your financial plan.

One example is having a paid-up permanent insurance policy during retirement. A paid-up policy is when no more premiums are due for the rest of the policy owner's life. This policy can provide peace of mind for a family in many ways. Here are some reasons a couple may value a permanent insurance policy:

  • What if there is a major stock market or real estate correction before the insured dies? The beneficiary may avoid selling a depreciated asset at a bad time.

  • What if the couple spends more than they originally planned while enjoying retirement? The surviving spouse will have some assets replenished through life insurance proceeds.

  • What if there is still debt outstanding when the insured dies? The surviving spouse will have the option to pay down the debt.

  • What if their goal were to leave an inheritance behind for the next generation? Life insurance proceeds pay out in a lump-sum, tax-free at the time of death.

The instant liquidity life insurance provides leaves beneficiaries with options and flexibility. This peace of mind can be invaluable for many families during retirement.

Permanent life insurance provides an efficient way to pass wealth to future generations. If you know how much to expect your policy to pay out, you can spend down your retirement assets with confidence. Since the death benefit is income tax free, you will know the exact amount of wealth that will pass to future generations when you die.

Having access to the cash value in a permanent insurance policy while you are alive can be a major benefit. You can access the cash value in a permanent policy while you are still alive. Assuming you've selected the right type of policy, you can expect your cash value to exceed the premiums paid into your policy over time.

Life insurance policies experience unique tax treatment. Cash value grows on a tax-deferred basis. This means taxes are not paid on interest earned within a permanent insurance policy. You can access cash value in any policy year on a tax-favored basis.

Here are some examples of when having access to cash value can be beneficial:

  • You have an emergency that requires immediate cash.

  • You want to make a major purchase.

  • You want to make a major investment.

You may prefer to avoid liquidating existing investment holdings or incurring debt. In these instances, you may find the access to cash value in your policy to be an attractive option to have.

Disadvantages

Permanent insurance policies require much higher premiums than term insurance policies. This factor in itself makes permanent insurance unaffordable for many households.

Properly funding a permanent life insurance policy is a long-term financial commitment. You need to pay premiums for many years to sufficiently fund a permanent policy. Stopping premium payments early will result in lower cash value and death benefit. Sometimes, you may lose life insurance protection altogether. This commitment may become a challenge if your income becomes disrupted.

Permanent insurance policies are more complex to understand and manage. Ongoing monitoring is necessary with policy components such as cash value and policy loans. Two examples that may need attention are outstanding policy loans or changes to policy interest rates.

Who Permanent Insurance is Most Suitable For

A permanent insurance policy is suitable for one seeking a permanent death benefit.

A permanent insurance policy is suitable for you if one or more of the following applies to you:

  • You are seeking a permanent death benefit

  • You are looking to build cash value

  • You are a disciplined saver with a long-term time horizon

Key considerations

Life insurance receives unique tax treatment. It is important to understand the different ways you can access your cash value. Options such as surrendering your basis or policy loans can avoid incurring taxes.

It is important to understand the impact of withdrawals have on your policy values. Be sure to work with a knowledgeable agent or financial planner when you decide to withdraw cash. A professional can help create a plan to avoid a policy lapse or tax consequences.

Adding a disability rider to your policy is worth considering. Also called a waiver of premium rider, this rider waives your premiums in a disability event. According to the Social Security Administration, a 20-year old has a one in four chance of becoming disabled during their working years. For this reason, the cost of the rider may be worthwhile for many professionals. 

Some carriers offer an optional long-term care rider. This rider gives you access to your death benefit in the event you need long-term care. Studies show over 66% of 65-year-olds will need long-term care in their lives. With LTC costs being a major financial risk during retirement, this rider has gained popularity. Unlike a standalone LTC policy, you will not lose unused benefits with a rider.

 

Conclusion

 

At this point, you have learned that the best type of life insurance policy for you today depends on factors such as your

  • Budget and savings habits

  • Expected future income

  • Length of protection desired

  • Desire for living benefits such as accumulating cash value

  • Financial plan

If you have a limited budget, chances are a term life insurance policy will be the most suitable for you today. There are some important considerations to keep in mind as you set up your term policy.

Your life insurance program does not have to be 100% term or permanent insurance. Having a combination of both policy types can make great sense for many policy owners. It may be affordable to complement your term policy with a smaller permanent policy. Setting up a permanent policy today locks in the lower cost of insurance at a younger age. This results in more efficient growth of policy values. 

Change is the one constant we are guaranteed to experience in our lives. Most professionals find that their income peaks in their early 50s. What is most suitable for you today may change in your future. Your future may not play out according to your original plans, for better or for worse. The best type of life insurance program should suit your needs today, while providing flexibility for your future. Work with an insurance expert to set up a term policy through a carrier who provides strong conversion options.

Last but not least, be sure to review your policy once a year. If you need to increase or lengthen coverage, make the changes while you are young and healthy.

About the Author
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Henry Hoang

CLU , CHFC , CLF

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