Last week’s post talked about why you might or might not need life insurance. Once the decision has been made that you need or want life insurance, it becomes crucial to get the appropriate death benefit amount and to get that death benefit with the most efficient cost to it.
It is essential to understand that the insurance costs increase as you age. The older you are, the more the annual cost of the premiums are. A 30-year-old buying a policy will pay less in premiums than a 50-year-old for the same amount of coverage. Health conditions also play a factor in premium costs. There are often classes of insurance – premium for those in good health, standard or substandard for those with some health conditions. Tobacco users will pay a higher premium than non-tobacco users.
Many insurance companies also charge a modal premium, meaning the more often you choose to pay the premium, the more you will pay. For example, say the annual premium is $1,000. If you pay it once a year, the payment will be $1,000. If you elect to pay the premium twice a year, each payment may be $550 for a total of $1,100. Quarterly payments may be $315 for a total of $1,260. Elect to pay the premium monthly, and the amount might be $115 for a total of $1,380. Some companies also discount if you have electronic transfers for the premium payments rather than wanting to mail in a check. To minimize your costs, pay attention to these details.
First decision – do you need temporary insurance or permanent? The temporary insurance, known as term insurance, lasts for a particular number of years. You purchase a policy for 10 years, 20 years, or 30 years. This is a no-frills policy. If you pay the premium, the policy remains in force. There is no accumulation of any cash value. At the end of the term, the policy ends, and there is no payout. The only payout will be if the person dies.
Since this is no-frills, this type of insurance has the lowest premiums. It is often perfect for young families with children. A family with young children often has a considerable need since income will need to be replaced for 15 to 20 years; there may be a larger mortgage since it would be newer, and there is a need for college funding. Term insurance provides the largest death benefit for the lowest premium.
A 30-year term policy for someone in their early 30s will get that individual through raising their children, paying for college, and potentially to retirement. For someone in their 50s concerned about income replacement until retirement, a 10-year or 15-year term policy might be precisely what is needed. Some individuals will purchase a term policy for the value of their outstanding mortgage to be paid off in case of a death occurring.
A term policy can be purchased with a level premium per year – the premium remains steady for the policy’s entire length. Term insurance can be a renewable premium each year, with the premium costs changing every year or every certain number of years. When the premiums are level, the insurance company is holding funds at the beginning of the policy when the premiums are lower to use up as the premiums get higher later. You, as the policyholder, have no access to these funds.
Term policies may add a rider of being convertible. Convertible means the policy has the option of transitioning from a term policy to permanent insurance. Permanent insurance is just as it sounds. If you pay the premiums, the insurance will continue in place. Permanent insurance will build cash value. As long as the premiums are paid the insurance will stay in existence. There are several different types of permanent insurance – whole life, universal life, variable universal, or indexed universal. These types of policies can have riders attached to them. A rider is an additional benefit – some of which come automatically with no cost and some of which have a cost attached to them and will increase the premium.
When purchasing permanent insurance, the premiums are considering that you will be paying premiums for when you are 40 years old, when you are 55 years old, when you are 70 years old, and when you are 90 years old. The older policies assumed you would be living to age 100 when the insurance companies were calculating the premiums. Many of the newer policies assume you will be living to age 120 when they calculate the premiums. This makes the annual premium costs for permanent insurance more than the premium for term insurance.
The whole life is the no-frill of permanent insurance. The premium is set when the policy starts and remains consistent throughout. The policy will build cash value, so if you decide to get rid of the policy, you will get a cash payment. If you continue to pay the premium, the policy remains in force.
Universal life provides flexibility. There is a minimum premium amount that must be paid to cover the insurance costs. Over and above that, premium payments are flexible. With flexible premiums, the death benefit will be adjusted depending on what premiums are paid over the years. The accumulated cash surrender value can be used to pay a premium if the owner wants to skip one. The cash value will be dependent on what premiums are paid and how those premiums are invested. The insurance charges will increase each year. Any excess premiums at the beginning will accumulate to pay the higher premiums as the insured ages.
Universal life policies can use cash equivalents for the premium excesses. In this case, the excess premiums will earn money market or bond interest rates. It is also possible to choose a variable universal life policy. In this case, the excess premium payments are put into subaccounts that are market-invested. Subaccounts doing well will provide a larger buffer of excess premiums. If the market declines, there is a decline in the excess premiums. One of the newer insurance types of universal life policies is indexed universal life. Like other indexed products, these policies provide market participation while limiting risk in a down market. It is the variable or indexed universal life policies that can be appropriate to use as investment policies.
How do you decide? You need first to decide how much insurance you need. Is term or permanent insurance a better fit? If you want permanent insurance, you need to decide if you want the guarantees of whole life insurance or the flexibility of universal insurance. Policies from insurance companies need to be reviewed to determine the difference between the terms. Riders can be different from policy to policy. The administrative costs need to be considered. If looking at variable or indexed policies, you need to consider the underlying investments within the policies. There also needs to be a consideration of the ratings of the insurance companies. There are rating services. You want to make sure if you are purchasing a policy from a company that it is stable, and you are comfortable that it will be around for years to come.
We so often see individuals with not enough insurance, which leaves them at risk if something happens. Just as often, we see individuals paying premiums on insurance that they do not need anymore. Individuals hold policies that do not meet their needs. Often, we find individuals are holding policies that they do not understand. Planning with Purpose does offer an insurance audit to review policy needs and determine if what you have is what you need. If you are interested, please contact the office to schedule an audit.