Life insurance policies fall into one of two categories: term or permanent:
- Term life insurance: This policy covers a specified term, such as 10, 20, or 30 years. If the insured person passes away during the term, the policy pays out a death benefit to the beneficiaries. Term life insurance is generally considered a lower-risk policy because it provides a simple death benefit protection without a savings or investment component. As a result, it tends to have lower premiums than other life insurance policies. However, a small percentage of term policies ever pay out a claim, actuarially speaking.
- Permanent life insurance: Permanent life insurance policies, such as whole or universal life, offer coverage for the insured's entire lifetime. These policies provide a death benefit and accumulate cash value over time, which can be invested. The cash value component introduces an investment or savings element, which can provide returns but also comes with generally higher premiums and more complex features than term life insurance.
All permanent life insurance policies offer lifetime coverage and cash value accumulation. Whether a cash-value insurance policy suits individuals depends on their financial goals and risk tolerance. It can be a valuable tool for those who want lifelong coverage, tax-advantaged savings, and even estate planning benefits. Still, it's essential to carefully weigh the costs and benefits and consult a financial advisor or insurance expert to make an informed decision.
This guide breaks down the pros and cons of permanent policies and their various cash value components.
Whole life insurance
- Guaranteed premiums and cash value: Premiums for whole life insurance are typically fixed and guaranteed for the policy's life, providing predictability and stability in financial planning. It also offers tax-deferred cash value that grows at a guaranteed yearly rate.
- Less risk: Compared to other permanent policies, whole life insurance is less risky and rarely lapses in coverage, making it a good option for those looking for a stable return on investment.
- Dividends: You may also receive dividends if the policy is from a mutual company. Annual profits from the carrier can be redistributed as dividends to their policyholders each year that there is a profit. Dividends can be used in several ways, such as distributed as cash, used to reduce premiums, or used to buy additional insurance. However, it is important to note that dividends are never guaranteed and are provided at the carrier's discretion.
- Estate planning: Whole life insurance can be used as an estate planning tool to provide liquidity to pay estate taxes or ensure wealth is transferred to heirs efficiently.
- Cost: Given the guaranteed elements of a whole life policy - premiums, cash value, and death benefit - it tends to be relatively more costly than other forms of permanent insurance.
- Limited investment options: The cash value component typically grows at a fixed and relatively low interest rate set by the insurance company. Individuals have limited control over how the cash value is invested. Additionally, the cash value's growth rate is often lower than what you could earn by investing in stocks or bonds.
- Reduced flexibility on premiums: Whole life insurance policies typically offer less flexibility in premium payments than other types of permanent life insurance, such as universal life insurance. The premium payment amount is predetermined and generally cannot be adjusted to suit changing financial circumstances.
Universal life insurance
- Flexible premiums: Universal life insurance allows policyholders to adjust the premium payments within certain limits, which can be helpful if their financial situation changes over time.
- Cash value growth: The cash value account will earn interest and grow on a tax-deferred basis at a rate set forth by the insurance carrier, which can change over time.
- Adjustable death benefit: The insured can increase or decrease the policy's death benefit amount, subject to underwriting approval, allowing for more tailored coverage for evolving needs.
- Downside protection: Universal life policies have guaranteed minimum interest rates set by the carrier to ensure the crediting rate stays within a certain level during periods of poor marketing performance.
- Limited growth potential: While the policy’s downside protection offers stability, there is limited growth potential relative to other forms of permanent insurance. The policy’s cash value will never grow more than the stated interest rate. Further, if interest rates drop and the carrier drops their crediting rate on the policy, the cash value may not grow as initially anticipated.
- May require additional monitoring: Compared to whole life, universal life insurance may require greater attention to ensure the policy is adequately funded and is in no danger of a premature lapse.
Indexed universal life
- Growth potential: Indexed universal life (IUL) policies can offer higher cash value growth potential than other permanent policies, specifically whole life and traditional universal life because the cash value growth is tied to the performance of a stock market index.
- Downside protection: Like universal life, IUL policies have a minimum guaranteed interest rate, ensuring the cash value doesn't decline due to the underlying index performing poorly.
- Flexible premiums: Like universal life, IUL policyholders can often adjust premium payments within certain limits, offering flexibility to accommodate changing financial circumstances.
- Complexity: IUL policies can be complex, with multiple moving parts, including participation rates, caps, and spreads determining how the cash value is credited. Understanding these features and their impact on policy performance can be challenging.
- Limited upside: While IUL offers the potential for cash value growth, it typically includes caps and participation rates that limit the extent of gains when the underlying index performs well. This can result in lower returns than investing directly in the stock market.
- Costs and fees: IUL policies often come with various expenses, including administrative and insurance charges, which can reduce the cash value growth over time.
- Market risk: While IUL policies provide downside protection, they are still subject to market risk. If the underlying index performs poorly for an extended period, the policy's cash value growth can be impacted.
Variable life insurance
- Flexible premiums: As with other forms of universal life insurance, variable universal life (VUL) offers the option to adjust premiums as financial circumstances change.
- Potential for higher returns: VUL offers the potential for cash value growth that can outperform traditional fixed-interest policies and indexed universal life policies. It allows policyholders to invest in various investment sub-accounts, like mutual funds, potentially generating higher returns over the long term.
- Investment control: VUL policies allow the policyholder to maintain a certain level of self-directed control over how their life insurance premiums are invested.
- Adjustable death benefit: Variable life insurance allows policyholders to change the death benefit amount over time, allowing them to align the coverage with their evolving financial needs.
- Investment risk: The main disadvantage of variable life insurance is the exposure to investment risk. The cash value is directly linked to the performance of the selected investment options, which means it can fluctuate significantly and potentially result in losses during market downturns. Unlike traditional UL and IUL policies, VUL generally does not offer downside protection and can be severely impacted by poor market performance.
- Complexity: Variable life insurance policies can be complex, with multiple investment options and fees that make them difficult to understand. Policyholders must actively manage their investments, which may require financial expertise.
- Costs and fees: Variable life insurance policies often come with higher fees than other types of life insurance. This can include management fees and administrative charges, impacting cash value growth over time.
- Disclosure and documentation: Regulatory requirements for variable life insurance policies often involve extensive documentation and disclosure, which can be burdensome for policyholders and insurance agents.
A brokerage like Modern Life is crucial in helping advisors secure their clients' best cash value policies. Here's how:
- Access to multiple carriers: Brokers work with numerous insurance carriers, giving advisors access to various permanent life insurance options. This enables advisors to compare policies and find the one that best suits their clients' needs.
- Product expertise: Brokers have in-depth knowledge of the various permanent life insurance products. They can provide advisors with insights into different policies' features, benefits, and limitations, helping advisors make informed recommendations to their clients.
- Underwriting support: Brokers often have underwriting experts who can assist advisors in preparing client applications. For example, Modern Life recently helped an advisor secure coverage for a difficult-to-insure client who was a cannabis entrepreneur.
- Customized solutions: A brokerage will work closely with advisors to understand their clients' unique financial situations and goals. They can help tailor permanent life insurance solutions to meet these specific needs like estate planning, wealth accumulation, or retirement income.
- Educational content: Brokers often provide advisors with ongoing insights and resources. This includes updates on industry trends, changes in insurance products, and strategies for effectively selling permanent life insurance. For example, Modern Life has numerous webinar recordings to help advisors navigate complex topics.
- Technology and tools: Modern Life offers advisors a seamless platform with tools that streamline the insurance application and management process, like an intuitive chatbot feature.
In summary, a brokerage can be a valuable partner for advisors seeking to provide their clients with the best permanent life insurance policies. If Modern Life sounds like the best solution for your firm, fill out the form below to request a demo.
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