There are many types of insurance and many ways to look at how it fits into your financial plan.
In my last column I wrote about term insurance being the “if you die prematurely” option. In this column, I’m going to do a basic review of permanent life insurance plans.
There are three types of permanent insurance: term to 100, whole life and universal life plans. These are all long-term plans. Unlike pure term insurance, they’re designed to provide coverage if you die prematurely and for the when-you-die situation.
Since permanent insurance will at some point have to pay out the benefits, as long as the premiums are paid, the cost is substantially higher than pure term insurance. With term insurance, many policies lapse as they age due to either cost increases or the fact there’s no longer a need and people cancel the policy. This means many term insurance policies never pay out, whereas permanent policies often do.
Permanent insurance is meant to cover off a larger array of needs than term insurance does. While all insurance can be used to replace lost income, permanent insurance has many other potential uses and benefits:
- to build, protect and grow wealth efficiently;
- to efficiently transfer wealth from one generation to another;
- to cover off the success tax liability that occurs upon the passing of the last spouse;
- to fund large charitable donations from your estate;
- used by business owners as a planning tool.
Term-to-100 (T100) is the least expensive permanent policy. However, that also means it has the fewest bells and whistles. A T100 plan provides a level fixed premium, usually payable until age 100, and a level death benefit. Some also offer reduced paid-up or cash values.
There are two considerable drawbacks here. You have to pay for your whole life, and the benefit gets eroded over time due to inflation. If you stop paying and your plan doesn’t have a reduced paid-up or cash value option, you’ve lost all the money you put into the plan. And the cost has likely been significantly higher than what a term policy would have been.
With a whole life policy, you get some added flexibility as you may be able to reduce or stop payments. And often dividends inside the policy can be used to increase the amount of the death benefits or pay your premiums for you. If you have to stop payments for a while, sometimes the cash value in the plan can keep your insurance in place. These plans can grow in value and provide more coverage over time. However, be aware of the impact of long-term inflation when looking at these plans.
A universal life plan is similar to a whole like plan except you have more control over a universal life plan. With universal life, there are several cost options, flexible deposits and often a wide array of investment opportunities. These options allow greater flexibility than a standard whole life plan. And while that can be good, it needs to be managed, rather than purchased and forgotten about.
Universal life plans can be very complicated and, like your financial plan, these policies should be reviewed annually with your financial adviser or insurance adviser.
If you have a short-term need and that’s your primary focus, and you have a limited budget, your best bet is likely to stick to pure term insurance or a combination of term and permanent. And try to purchase the amount of coverage you require rather than the amount of permanent coverage you can afford.
As your financial situation changes, you can look at life insurance’s other uses in your financial plan.
Bill Green is an hourly financial and estate planner, public speaker and author of The Success Tax Shuffle.