An overview of the kinds of term and permanent life insurance
An overview of the kinds of term and permanent life insurance
Life insurance is an important financial planning tool to help individuals, from retirement savers to business owners, prepare for the future. Insurance offers more than just protection: it can provide peace of mind and financial stability in times of need.
There are two general types of life insurance policies: term insurance and permanent cash value insurance. Term insurance offers temporary protection for a specified period, and the death benefit is paid if the insured passes away within that term. However, if the insured survives the term, the coverage ends.
Permanent cash value insurance offers lifetime protection as long as the policy remains active. The death benefit is paid regardless of when the insured passes away, and the policy accumulates cash value that can be used during the insured's lifetime. Withdrawals and loans will reduce the policy's death benefit and cash value available for use.
Term insurance provides temporary coverage for a specific period. If the insured individual passes away within that term, the death benefit is paid. If the insured survives the term, coverage ends.
Term life insurance policies have several advantages, including low initial premiums and flexibility to buy coverage to account for for short-term needs. Most term policies are a specific type of insurance known as “level term,” which guarantees that the premium payments and death benefit remain the same for the length of the policy (usually 10, 20 or 30 years).
Many policies are considered renewable, which means that the policyholder can opt to extend their coverage without undergoing a new underwriting process or medical exam. However, the premiums may increase upon renewal, and the policyholder may need to meet medical qualifications in order to do so. These policies are best suited for those with specific, temporary protection needs and can offer policy dividends, but do not build cash values.
Some term insurance policies are decreasing, which means that premiums stay level, but the death benefit declines over time. These policies are ideal for those with needs that diminish over time, such as paying off a mortgage. Like renewable term policies, decreasing term policies may offer policy dividends but do not accumulate cash values.
Some term policies are convertible, which means that the policyholder may elect to change their term policy into a permanent cash value policy without undergoing a new underwriting process or medical exam. This option provides flexibility for those who may want to extend their coverage and build cash value in the future. Converting the policy may result in higher premium payments.
While term life policies provide protection for a specific period of time, permanent life insurance policies provide lifelong protection and generally accrue cash value that can be accessed by the policyholder. There are various types of permanent insurance policies, each with its own unique features and benefits: whole life, universal life, indexed universal life, and variable universal life.
Whole life insurance is a traditional form of permanent life insurance that offers guaranteed lifetime protection, as long as the policy is kept in force. With whole life insurance, policyowners pay a fixed, level premium, and cash values accumulate at a guaranteed rate of return. This type of policy is best suited for individuals who desire long-term financial security and appreciate the stability of guaranteed cash values and death benefits. One of the main advantages of whole life insurance is the guaranteed lifetime protection, which can help create a "savings habit." However, whole life policies lack flexibility on premium payments, as well as lower cash value growth compared to other types of permanent life insurance.
Universal life (UL) insurance offers more flexibility than whole life insurance, allowing policyowners to adjust their premiums and death benefits as their needs change. The cash value growth in a universal life policy is based on a fixed interest rate, which may vary over time but will never be less than a guaranteed minimum interest rate. This type of policy is best suited for individuals who want premium flexibility and cash value accumulations that reflect current fixed interest rate returns. Lifetime insurance protection and premium flexibility are key advantages of universal life insurance. However, required premiums may increase as the insured gets older, and if current interest rates are low, cash value growth may be disappointing.
Indexed universal life (IUL) insurance is a variation of universal life insurance that offers the potential for higher interest rates based on equity market performance. The cash value in an indexed universal life policy is credited with interest based on the performance of a stock market index, such as the Standard and Poor's 500 Composite Stock Index (S&P 500 Index). This type of policy is best suited for individuals who want the opportunity to earn higher interest rates based on equity market performance while retaining the flexibility and cash value growth components of universal life insurance. Indexed universal life insurance offers lifetime insurance protection, premium flexibility, and the potential for higher cash value growth during strong equity market periods. However, required premiums may increase as the insured gets older, and an equity market downturn may impact cash value growth in the policy.
Variable universal life (VUL) insurance combines the premium flexibility of universal life insurance with a choice of investment options. The policyowner selects the investment options, and the cash value available depends on the performance of the chosen investments. This type of policy is best suited for individuals who want a choice of investment options along with premium and death benefit flexibility. Variable universal life insurance offers premium flexibility, a variety of investment options, and the potential for higher cash value accumulations and increasing death benefits based on actual investment performance. However, required premiums may increase significantly as the insured gets older, and cash values can decrease during times of poor market performance, possibly resulting in a loss of principal. The policyowner assumes the investment risk in a VUL policy.
In conclusion, each type of permanent life insurance policy offers its own unique features and benefits. Whole life insurance provides guaranteed cash values and death benefits, while universal life, indexed universal life, and variable universal life insurance policies offer varying levels of flexibility and potential for higher cash value growth. When choosing a permanent life insurance policy, it is important to consider individual financial goals, risk tolerance, and desired level of flexibility.
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