When you go to the doctor for a wellness visit, you typically take a variety of tests, talk about whether anything has been bothering you, and end up having a fairly comprehensive discussion about your health. Taking your overall health into perspective allows you to make educated decisions on how to live your best life. The same model applies when you talk with an advisor about your financial health. Looking at your current portfolio, needs vs. wants, and overall diversification should be the pillars of your financial health. If you identify a deficiency in your financial strategy, you can adjust your plan to live your best financial life.
One of the key ingredients in financial health that often gets overlooked is your life insurance. This asset, while not necessarily tied to the stock market, can offer significant diversification including cash accumulation for tax free retirement, accelerated payments for serious health situations, and of course, income tax free benefits to your heirs. Deciding which insurance product is right for you is a daunting task on your own, so working with a qualified consultant who will put your needs first makes this process painless and streamlined.
For those who like to do a little research when preparing to speak with a professional, let us make your job a bit easier by helping you understand the basic differences between various types of life insurance products in the market.
When looking at life insurance, you need to first identify the difference between the four major categories: 1) Term Life; 2) Universal Life; 3) Whole Life, 4) Variable Universal Life. All of these products have subcomponents that differentiate them from one another as well. Always make sure to do a cost-benefit analysis during your decision-making process. Let’s spend a moment breaking down each category.
The most basic and cost-effective form of life insurance you can purchase. This product offers a guaranteed death benefit with level premiums for a set number of years, generally 10, 15, 20, 25, or 30 years. These products are the cheapest, because you are buying a death benefit only for a set number of years. There are a few term products that offer living benefits for chronic or critical illness should you get sick during the term. During the term of years, you typically (depending on the carrier) have the right to convert to a permanent product without new underwriting. This conversion may be done for any reason, but often occurs if the insured becomes uninsurable and needs to maintain adequate coverage beyond the initial term. Note, many carriers limit the conversion product to something undesirable, so please check your conversion options before purchase. If you don’t convert to a permanent product the most likely outcome is that the policy will lapse at the end of the term. If you find yourself in a desperate situation, the carrier will allow you to continue paying an ever increasing premium each year to maintain the coverage (this premium will become largely unaffordable very, very quickly). Most often, term insurance works best for young families who want to ensure that the mortgage and kids’ education can be covered if disaster strikes and one or both parents pass away. Additionally, many business owners will use term insurance as part of their succession planning and key person strategies.
Universal Life Insurance:
If a limited term of insurance is not for you, and/or if you have retirement planning needs, then exploring permanent insurance that lasts a lifetime may make a better fit. Within the category of Universal Life, you will find Guaranteed or Current Assumption options. Additionally, the most recent and by far most popular product type of Universal Life is called Indexed Universal Life or IUL (more on this in a minute). What’s important to know about this type of insurance is that the premiums are somewhat flexible, so you can design a policy around your financial needs. If you want to start off putting more money into your policy and lessen it over time, you can. If you come into a large sum of money down the road and want to put some of it in your policy, you can. These contracts tend to offer some form of cash accumulation that works particularly well in the Indexed products mentioned above. Additionally, you have the ability to guarantee the death benefit and any other riders such as long-term care, chronic illness, or critical illness (which allow you to accelerate the death benefit during life). For this reason, IULs when designed correctly can make a favorable alternative to traditional Long Term Care plans. Many people also use Indexed Universal Life policies as a college savings strategy, since 529 Plans count against applicants for Financial Aid whereas IULs do not. Regarding Indexed Universal Life, the popularity is driven by the fact that the interest credits can rise as high as 12% or more when the markets do well, and yet will limit your risk to a floor of 0% should the markets experience a loss. Because these products are not investments, they are able to act in concert with the equities market without being directly tied to them. When it comes to Universal Life with accumulated cash value, you may either take tax free loans, partial withdrawals, or even completely surrender the policy for the full cash surrender value. All of these options make Universal Life a very attractive option. Premiums for Universal Life cost quite a bit more then term, but far less then Whole Life. Typically, Universal Life works well for those with a bit more cash flow looking to diversify their retirement strategy, build in a known Long-Term Care strategy (with fixed premiums), and of course, have a death benefit available for whenever they need it.
Whole Life Insurance:
Like Universal Life, Whole Life is designed to last one’s whole lifetime. These policies are built with a significant number of guarantees and the ability to earn dividends. These dividends can be used to purchase additional insurance which will also add to the policy’s cash value. While dividends are not always guaranteed, they are typically paid. Because of all of these fixed components, Whole Life is almost always the most expensive type of life insurance one can get. Unlike Universal Life, Whole Life has very limited flexibility and generally requires that your level premium be paid for life or set number of years in order to maintain all the guarantees. It is also less likely that Whole Life will offer riders for chronic illness or Long Term Care, although some carriers are starting to make that available. When it comes to Whole Life insurance, a person should have significant cash flow that will be available the person’s whole lifetime. Typically, these products are advisable for those with significant estate planning and wealth transfer needs. On occasion, these products also make for good retirement alternative solutions due to the tax-free nature of the loans. Beware, however, that Whole Life carriers generally charge a higher rate of interest on policy loans then Universal Life products. Also, since Whole Life is generally much more expensive than other types of permanent life insurance products, there can be an opportunity cost to using this kind of product vs. others that allow you to diversify a bit more.
Variable Universal Life Insurance
Wildly popular when the stock markets are booming, and potentially devastating when the market goes through a correction, Variable Universal Life is the most volatile product in the insurance market. While the product can be designed to last one’s lifetime and premiums are flexible as with Universal Life, the cash accumulation is directly tied to the equity markets and can go up significantly or drop like a lead balloon. The appeal with most Variable Life is that, theoretically, if the cash accumulation grows strongly enough, the insured can stop paying premiums, have a significant death benefit, and build cash savings to draw from. The risk, of course, is that if the equity markets fall, your policy could implode, leaving you with no cash and no death benefit. These products are typically made available to those who have high risk tolerance, significant cash flow, a long-time horizon, and view insurance more as speculative rather than for the purposes of protection. Note: these products may only be offered by an advisor who is both life and securities licensed. Also note, we typically advise clients against Variable Universal Life products as there are much better strategies available in the hands of a good advisor.
Wow that is a lot of information to try and take in, and we are just scratching the surface of Life Insurance. For those of you who are visual learners, let us sum up everything just discussed in the below chart:
Choosing the right policy to protect your family, your business, and your legacy is no small matter. You don’t take your physical and mental wellness lightly, and you shouldn’t neglect your financial wellness either. Hopefully this overview has helped provide you with a foundational understanding of how and when different types of life insurance can offer value. Now that you have become a little more familiar with the subject, let our expert consultants at Quantum Insurance Services help with designing and implementing the perfect insurance plan to meet your needs.