What type of life insurance coverage should I purchase?

What is Universal Life Insurance?
Universal life insurance (UL) is a combination of term insurance and whole life insurance that provides affordable death protection with considerable policy flexibility.
With universal life, the costs of insurance are based on annual renewable term insurance rates that increase annually as the age of the insured increases. Additionally, universal life offers a cash value account that grows tax-deferred at a current interest rate much like whole life insurance. Universal life essentially combines the advantages of low cost term insurance with a tax deferred savings vehicle. This unique policy design allows for adjustable policy premiums and insurance face amounts making the UL policy a versatile tool that is adaptable to changing situations and circumstances.
Universal life is known for its flexible premium payment options. Because universal life insurance policy costs are based on annually renewable term insurance, they can be separated and identified. Knowing the actual policy costs, the policy owner has the option of paying the minimum premium that is required to cover these basic costs or to pay a higher premium and take advantage of the tax deferred account to accumulate cash values. The choice is with the policy owner as to how a UL policy is funded.
In fact, premiums may be paid on a non-scheduled basis or even skipped. As long the minimum required premium is made or the policy has enough cash value to cover the current policy costs, the coverage will remain in force. However, premium payments and policy costs should be closely monitored to assure that over the long term that the policy’s cash values increase to offset insurance cost increases in the future. As discussed, annual renewable term insurance increases in price annually as the insured gets older. These cost increases must be paid out of current policy premiums or the policy’s existing cash values. If the premium is not sufficient to cover policy costs, the cash value account makes up the difference. Once the cash value account reaches zero, either premiums must be increased substantially to cover the increasing insurance costs or the policy lapses with no value. For more details see, “How a Universal Life insurance Policy Works”.

Universal life insurance offers two death benefit options. With death benefit Option A, commonly referred to as the “level death benefit option”, the insurance face amount remains the same regardless of cash value growth as long as changes are not made to the policy. With death benefit Option B, or the “increasing death benefit option”, the insurance death benefit is determined by adding the current policy cash value to the initial policy face amount. Option A is commonly used in situations where cash value accumulation is the main policy objective. Option B, used more infrequently, is best for when greater amounts of insurance are required.
With universal life, the policy face amount may be raised or lowered depending on the specific policy and subject to contract minimums. In all cases, when coverage is increased, the insurance company will require proof of good health. Additionally, when coverage is decreased, some companies may require a surrender charge to be paid. Either way, having the option to increase or decrease the insurance coverage amount provides significant flexibility to the policy owner.
For example, let’s say you currently own a UL policy with a face amount of $1,000,000. The policy was initially bought when your three children were still in school and had a sizeable mortgage balance. Since then, all of your children have graduated college and you no longer have a mortgage. The initial $1,000,000 of universal life insurance is no longer required, but some coverage still needs to be maintained. In this case, you can reduce the policy’s face amount to a level that meets your current needs without any hassle. Additionally, you now have the option to change your premium payment strategy and increase premiums to grow cash values.
Universal life policies have contractually guaranteed minimum interest rates of between 2-4% annually. The interest rate is credited annually to the policy’s cash value account which grows tax deferred. Currently, most UL policies pay a higher current interest rate that is based on the prevailing economic conditions. Over time, the actual interest rate credited to the policy’s cash value will vary somewhat significantly. Because, universal life policies are flexible and are subject to several variables, the policyholder should always pay special attention to the growth of the cash value as it relates to the projected growth and projected premium payments. A careful review of your policy’s annual in force illustration will provide valuable insight on the long term performance of your policy. For more information see, “What is an Inforce Illustration?”
Universal life insurance is a valuable life insurance tool because it offers low cost life insurance protection with the ability to grow cash values that are tax deferred. The flexibility of universal life is what makes UL policies so unique. Over time, the ability to customize a policy to meet your changing needs makes universal life and excellent policy choice.

What is Whole Life Insurance?

Whole life, also known as permanent life or ordinary life insurance, is a type of life insurance that is designed to last a lifetime and offers a guaranteed accumulation fund that grows tax deferred.

Unlike term or universal life insurance, whole life has a fixed guaranteed premium and a fixed guaranteed death benefit for the insured’s lifetime. Additionally, permanent life insurance builds guaranteed cash values. With most whole life policies, premium payments are required until the earlier of the insured’s death or to their age100. At age 100, the insured receives the policy’s cash value account which equals the policy’s face amount. At that time, the policy is said to endow and the life insurance coverage ends.

Permanent life insurance premiums are primarily determined by the number of years between an insured’s current age and their age 100. As mentioned, premiums for whole life are guaranteed to remain level for the life of the policy. In order to guarantee level premium payments, the insurance company requires a higher premium in the policy’s early years to balance the significantly higher insurance costs at older ages. Therefore, whole life insurance is the most expensive form of life insurance in the short-run but may be the most cost effective over the long-run. With whole life, you are actually self-funding your life insurance policy.

Whole life insurance policies build guaranteed cash values that grow tax deferred. In the first few years, due to sales fees and early policy costs, cash value growth is very low. However, over time guaranteed cash values can become significant. Actual cash value growth will depend on the face amount of the insurance policy, the amount of the premium payment and how long the policy has been inforce. In general, the larger the policy’s face amount, the higher the required premium and the larger the cash value growth. Furthermore, policies that have been in effect for a longer time period will also have better cash growth.

Additionally, the insurance company's investment, earnings and claims experience also has an impact on cash value growth. Permanent life insurance can be classified as either participating or nonparticipating. With a participating whole life policy, after all the claims and expenses of the insurance company have been paid for a given policy year, the policy owner is entitled to “participate” in any surplus that remains. This surplus payment is known as a policy dividend and is considered to be a return of excess policy premiums. Dividends are not guaranteed and there are no income taxes paid on life insurance policy dividends. On the other hand, nonparticipating policies do not pay policy dividends. If you are considering whole life insurance, a participating policy is always the best choice.

Policy cash values may be accessed in the form of withdrawals, policy loans or policy surrender. Tax free withdrawals can be made up to the basis of the policy and then cash values accessed via policy loans. The policy basis is the total amount of policy premiums paid to date. Any withdrawal up to the basis is considered return of premium and no taxes are payable. Any withdrawals beyond the policy basis would be subject to income taxation. Once cash values have been withdrawn up to the policy’s basis, a tax free policy loan can be used to draw down cash values. Policy loans are charged a market interest rate and accrue interest over time. As long as the policy retains enough cash value to pay insurance premiums, taxes can be avoided using the withdrawal to basis then policy loan approach. At the insured’s death, any loan balance will be deducted from the policy’s death benefit.

There are many variations of whole life insurance including: participating life, adjustable life, modified life, single-pay life, variable life, and survivorship life or second-to-die insurance. The most important consideration when choosing a whole life policy is to make sure that the policy you choose is a participating policy with good financial ratings.

Advantages of Whole Life:
Guaranteed coverage for life

Premiums are fixed for the life of the policy

Guaranteed cash values

Tax deferred growth of cash value

Policies may pay non taxable dividends

Disadvantages of Whole Life:
Too expensive over the short-run

May not be able to afford the coverage needed

Policies are not as flexible as other options

Returns on cash value may be lower than expected

What Is Term Life Insurance?

Term life insurance also known as “temporary insurance” is designed to provide low cost protection for risk of premature death and will pay a benefit only if the covered individual dies within the given term period.
There is no cash value growth with term life insurance. Therefore, premiums for term are much lower over the short-run than any other type of life insurance. Actual costs of term insurance are based on the age, gender, lifestyle and health of the insured. After the initial term period, the cost of insurance will increase as the insured gets older. Over time, due to age increases, policy costs will eventually become cost prohibitive. Therefore, term insurance is best used in cases where the insurance is needed for a limited time.

Two important contractual features of term life insurance are the renewable provision and the conversion privilege. The policy’s renewable provision permits a covered individual to continue the insurance policy beyond the initial term period without providing evidence of good health. The costs beyond the initial term period will increase but the insurance company cannot cancel the insurance policy for any reason as long as it is renewable. Most policies are renewable to age 95.

The conversion privilege is as equally important and allows a policyholder to “convert” or exchange a term policy for a whole life or universal life policy without evidence of insurability. The conversion of a term policy is done at the insured’s current age and the premiums to convert to more permanent life insurance will be higher. The conversion privilege is especially important in situations where health changes impact an individual’s ability to get competitively priced insurance or especially when the individual is uninsurable.

There are several different forms of term life insurance policies. The types of term life include annual renewable term (ART), level term, decreasing term, return of premium (ROP) term, and lifetime guaranteed term insurance. Currently, the most popular term life policies are level term life, ROP term and lifetime guaranteed term. For more information on term insurance see, "What are the Types of Term Life Insurance?"


Advantages of Term Life:
Premium payments for term insurance are usually much lower than whole life

Affordability allows for increased amounts of insurance when it's needed most

Great for covering temporary needs such as notes, mortgages, etc

Disadvantages of Term Life:
Payments will increase after the initial guarantee (level) premium period

Cost prohibitive over the long-run

You can outlive the coverage

No cash accumulation value