Life insurance is a bit different from other policy types. You may have car or flood insurance and never get into a fender bender or experience a category five hurricane. But, if you have it, you will eventually use your life insurance. Life insurance covers that unavoidable “accident,” and those who overlook it are omitting a fundamental part of their long term financial planning.
But the necessity of life insurance shouldn’t prompt a rash decision. Take time to understand the basics before you start paying premiums. No life insurance plan is one-size-fits-all. And choosing the right one will save you time and money.
Life Insurance Isn’t Complex
In the hunt for the right life insurance, it’s normal to get confused. Some policies go by different names, even though they’re the same thing. Insurance is a competitive market, and companies look for any edge to get your business. They tweak policy terms, adjust benefits, and charge premium rates to appeal to specific groups. The result is a hodgepodge of insurance types.
That’s why you will see plan names like universal, variable universal, simplified issue, or guaranteed issue. There are important differences among these policies to be sure. But at their core, each is either a term life or whole life insurance policy. The only difference is the benefits thrown in to appeal to your specific needs.
Term Life Insurance
Some folks only want insurance for a specific period. That’s when term life insurance is a good choice. For example, a breadwinner may want to insure family members dependent on his or her income while they’re working. Or a member of the military may take out short-term insurance for their deployment. Whatever the reason, some people only need life insurance for specific terms. And you can buy term life policies for periods as short as five years. Here are the things to know about term life insurance.
- If you die before your policy term is up, the company pays your death benefit
- If you die after the policy term ends, the benefit isn’t paid
- Most policy terms are for 10, 20, or 30 years
- Your death benefit can be paid in a lump sum, monthly payment, or through an annuity
- Term life policies usually expire when you turn 80. And you can’t get another one. So, you’re limited in your coverage. But because of their simplicity and lower premiums, term life policies are generally a good option for young, healthy people and those with limited budgets.
Whole Life Insurance
As the name suggests, whole life policies cover you for your whole life. Often referred to as permanent policies, whole life plans never expire as long as you pay your premium. Plus, these types of policies build cash value, so they work as an investment as well as coverage.
Think of cash value as a savings account attached to your policy. With each monthly premium paid, a small part will go towards your savings. And that cash value will accrue interest over time, making you even more money. Here are some things to know about whole life insurance policies:
- You can borrow against your cash value
- You keep your cash value when you cancel your policy
- Your savings are tax-deferred
- The interest rate you earn will depend on your policy
Some variations of whole life policies, like universal life insurance, let you borrow money from your cash value savings. And others have flexible payment plans that let you use the cash value to pay your premiums. And if you make enough interest per month, you can use it to pay for your policy!
One caveat: with a whole life policy, your dependents get the cash value plus the death benefit when you die. But with universal life policies, only the death benefit is paid.
There’s No Free Lunch
Insurance companies build plans to maximize their revenue, which means limiting their payouts. There’s no free lunch when it comes to insurance. If a plan’s benefits seem too good to be true, you can bet the company has restrictions in place to offset the risk they’re taking. For example, you may run into “guaranteed plans” that offer the following benefits:
- Monthly payments cannot increase
- Death benefits cannot decrease
- The policy never expires
- It builds cash value
- There are no health questions
These are all winning benefits and will attract people with pre-existing health issues. Of course, insurance companies know this. So, they build safeguards to mitigate losses. For example, companies offering policies like these have a death benefit restriction — a waiting period of two to three years. If you die within this period, your beneficiaries will not receive your death benefit. Instead, they will get any cash value (plus interest), along with a refund of your premiums.
Despite their restrictions, policies like these cover people who can’t get insurance otherwise. The point is that you should keep a “no free lunch” attitude when shopping for insurance. You’re not going to stumble up a secret insurance “deal” no one knows about — only a policy that either fits or doesn’t fit your needs.
Look for Policy Fit, Not Low Cost
You’re better off finding a policy that meets your needs than one that has enticing benefits or low monthly premiums. You save money in the long run when you avoid policies bloated with benefits that don’t match your current and/or future needs.
Maybe you’re only interested in saving your family the economic burden of paying for your final expenses. If so, then a burial policy would likely serve your needs and save you more money than a whole life policy. Final expense policies deal specifically with only burial costs, so they tend to be cheaper. But maybe you want to have more end-of-life options. If so, a policy with a cash value option would let you spend money for expenses outside of funeral costs.
In the end, you need a policy that fits what’s likely to be your future situation. And you’re the best person to plan for that.