Deciding whether to purchase life insurance is a difficult question on its own, and when you factor in the many types of insurance available, you have a genuine puzzle. Here’s a handy insurance overview to help you figure it all out.
Life insurance policies come in two flavors: term and whole life.
Term life insurance. Term insurance is temporary; it provides coverage for a term or period of time. Term insurance provides pure insurance protection without any build-up of cash value. It’s the least expensive form of insurance in the early years, but it becomes more expensive with every renewal as the risk of death increases.
Term insurance is either renewable or nonrenewable. A renewable term policy is more expensive, but may be worth the extra cost if you become uninsurable. An annual renewable term insurance policy provides fixed coverage for the present year and guarantees the right to renew for the following year at a specified rate. The premium will increase each year. Many term policies are issued for longer terms, e.g., 5 years, in which case the premium is usually flat during that period. These policies can typically be renewed for successive periods at higher rates.
A level term insurance policy is written for a fixed period of years, and total premiums for the entire period of coverage are divided into equal installments. Popular types of level term insurance include 5-year convertible and renewable term, 10-year convertible and renewable term, and term to age 65. Depending on your age, 20- and 30-year term polices may also be available.
Whole life insurance. In contrast to term insurance, whole life insurance features fixed premiums. Generally, premiums are payable for the life of the insured or until the policy endows (i.e., when the policy reserves equal the face value of the policy), usually at age 100. A whole life insurance policy has a guaranteed cash value reserve against which the policyholder can borrow income-tax free. Any loans remaining unpaid at the policyholder’s death are subtracted from the death benefit owed to the beneficiary. The temptation to purchase a whole life, as opposed to term life, insurance policy can be strong because premiums paid towards term life insurance are lost when the policy reaches the end of the term.
The irony of life insurance is that often young people with small children purchase little or no life insurance because they have a difficult time affording the premiums, but they are just the people who generally need more life insurance because you lose more future earnings the younger you are when you die. When young people do buy life insurance, they tend toward term life insurance because it’s generally much less expensive than whole life insurance.
This overview has hopefully helped to solve some of the insurance puzzle for you. For more information about different types of life insurance, turn to CEB’s Business Succession Planning: Strategies for California Estate Planners and Business Attorneys, chap 9 and Special Needs Trusts: Planning, Drafting and Administration, chap 7.
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