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When it comes to life insurance, there are two broad options: term life insurance — which remains in effect for a specific term — and permanent life insurance, which protects you for your entire life. Permanent life insurance is a bit more confusing than term life insurance because there are more options that may seem a bit complex at first.
What is Permanent Life Insurance?
While term life insurance protects you for a specific period of time (such as 10 or 30 years), permanent life insurance protects you for your entire life, as long as you keep up with the premiums. A permanent policy is more expensive than a term policy although it does have a cash value.
There are several financially related reasons to consider a permanent policy:
- The death benefit never goes away.
- Your policy accumulates cash value over time. You can access this value through a policy loan or a withdrawal.
- Several policy options for how you wish to save or invest the cash element.
- Death benefits are usually tax exempt for beneficiaries
- Yearly dividends. Some insurance companies allow you to earn yearly dividends on your life insurance policy.
There are also many additional nonfinancial reasons to consider some type of permanent policy:
- You may enjoy the peace of mind knowing that your insurance will remain in effect to protect your loved ones for as long as you live.
- Your policy can also serve as forced savings as it accumulates cash value.
- You may choose this type of policy to provide money for a minor child or loved one with special needs if something happens to you or leave a legacy for the people in your life.
Permanent policies are more complicated than term policies due to the number of policy options and decisions you need to make. There can also be some exposure to the risk of market fluctuations depending on the type of investment option you choose. Please see consult with a knowledgeable agent beforehand to make sure you fully understand the policy.
Different Types of Permanent Life Insurance
Whole Life Insurance
With a whole life insurance policy, you pay a premium for the rest of your life and receive a guaranteed death benefit that will be paid to a spouse or other beneficiaries when you die.
A whole life policy earns a specific interest rate set by your insurance company, which is based on investment returns. Any earnings beyond what covers the death benefit go toward your life insurance policy’s cash reserve. You can borrow against this reserve, allow it to accumulate, or even use it to pay your premiums.
Universal Life Insurance
A universal life insurance policy is similar to a whole life policy with a savings component that allows you to build cash value and earn interest. Universal policies also have a tax-deferred cash value in most cases.
The big difference with a universal policy is you can change your premium and death benefit for greater flexibility. This can give you a lower premium than you would pay for a whole life insurance policy. Also known as flexible premium life insurance, your premiums are separated into insurance, expense, and savings components, which gives you greater flexibility. You are required to pay one of these premiums while the other two can be adjusted in terms of frequency and amount.
You can think of a universal policy as having the best features of whole and term life insurance. Your overall cost will be lower than with a whole policy but you will still accumulate a cash reserve, just as you would with whole life coverage. You can change your premiums and/or coverage amount every year to fit your changing needs.
The flexibility of universal insurance does come at a price
The premiums will be higher than those for term life insurance. The fewer premiums you pay into your policy, the lower your cash value. This may even cause your policy to lapse if the premiums you pay aren’t enough to cover your mortality charge (the amount required to cover your death benefit for your age). Your policy will likely have a target premium that you must pay to keep your policy in force for a specific number of years.
Guaranteed Universal Life Insurance
If you aren’t comfortable accepting risk in an insurance product, guaranteed universal life (GUL) insurance may be a good option for you. This type of policy gives you a guaranteed premium and death benefit and it’s often used to leave a tax-free legacy for beneficiaries. The death benefit from a guaranteed UL policy may be used to pay off debts, cover estate taxes, set up a buy-sell agreement for your business, and more.
Guaranteed UL policies are easier to understand than most whole and universal life policies because there are no assumptions about interest rates in the future. As long as you keep up with the premiums, you will have guarantees. Your premiums will never increase and your death benefit will never be reduced. Guaranteed policies also tend to be inexpensive.
The downside is this type of policy has very little cash value and if you do anything with it, your policy’s guarantees are gone. The guarantees also may vanish if you miss a payment.
Indexed Universal Life Insurance
Like an indexed annuity, an indexed universal life insurance policy credits interest to your policy based on the market index performance (up to a limit) while buffering your policy’s cash value against downward movement. An IUL policy does not involve direct investment in the market; instead, the index performance is used to determine how much interest your policy’s cash value will earn.
This type of policy works much like a universal life insurance policy although it allows you to decide how much of your policy’s cash value fund you want to allocate to a fixed account and how much to allocate to an equity index account. In most cases, the principal amount in your indexed account will be guaranteed, although there will be a cap on the maximum return you can receive.
An IUL policy is a hybrid policy and it tends to be more affordable than other types of permanent life insurance, in part because there are no accounts to manage. While your upside potential is limited compared to variable whole life insurance, your investment is also safer.
Variable Life Insurance
Variable life insurance has been around for more than 30 years. This type of policy allows you to invest your premiums in securities. You will pay a fixed premium amount that is placed in a different investment account. Your policy’s cash value and death benefit for your beneficiaries will depend on the success of your investments.
Regardless of how your investment account performs, your policy’s death benefit will never drop below your policy’s face value.
The Downside: Risk
With a variable policy, most of your premium is invested in one or more investments, whether you choose bonds, mutual funds, stocks, or something else. This type of policy can be risky because your death benefits and cash value are based on how well your investments perform.
While your policy does have a guaranteed death benefit, you will need to pay additional premiums for it. You will usually fund the death benefit by paying an assumed interest rate of around 4%. If your policy fund performs better or worse than this assumed rate, your death benefit will increase or decline.
Universal Variable Life Insurance
A variable universal life (VUL) insurance policy is whole life insurance that the flexibility of adjusting your premium and coverage (like a universal policy) with the risk and opportunity of investing your cash reserve (like a variable policy). Along with the flexibility of a universal policy, you get to choose your own investments, not your insurance company. This means your insurer will not guarantee the cash value of your policy or an interest rate unless you invest your money in a fixed income account. In most cases, you will still have a guaranteed minimum death benefit, regardless of your policy’s cash value.
With a variable universal life policy, your cash reserves are invested in bonds, stocks, or securities. This means your policy will combine insurance coverage with the features of a mutual fund, although it is riskier than other options because your benefits are tied to the performance of the markets. You typically have at least ten investment accounts to choose from, each with a different level of risk and profit potential.
This type of policy can be used for many purposes, including funding a child’s education, supplementing retirement income, or covering long-term care. Variable life policies can help you look after your family with life insurance and give you access to managed investments to potentially accumulate a greater cash reserve.
The Risk of VUL Policies
The big advantage of this type of permanent life insurance is you can potentially take advantage of a strong market. Your policy’s value will be invested in sub-accounts that are subject to fluctuations in the market. Of course, this also comes with the risk of any investment. You will be responsible for choosing and managing your investment options.
You will also need to be sure you can keep up with your premiums. Otherwise, you risk your policy lapsing while the market (and your policy’s value) are down. You can choose to withdrawal or borrow from your policy, although this can reduce your death benefit and come with tax consequences.
With a variable life policy, your premiums will actually go toward three components: the insurance itself, your investments, and fees. There may be fund charges and other fees associated with a variable universal life policy.
You may also need to provide proof of good health to increase your death benefit or face surrender charges if you want to reduce your death benefit.
The Bottom Line
Your insurance needs will likely change over the years ahead. Permanent life insurance can give you peace of mind and offer the flexibility of changing your premiums and coverage or the means of investing your money while simultaneously ensuring your loved ones will receive a death benefit if something happens to you.
You have the choice of a more straightforward policy like whole or universal coverage or you can accept greater risk with the potential for a greater payout and cash value. Regardless of which option you choose, make sure you understand the requirements of your policy to avoid a lapse or additional costs.
Please keep in mind that underwriting guidelines can and DO vary greatly between carriers and this is often a complicated maze for consumers to navigate.
The secret to getting the lowest rate is placing you in a policy with the company who views you in the most favorable light.
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