Types of Policies:
Life Insurance FAQ
How much life insurance should you own?
What about buying life insurance for a spouse or children?
Should I buy term insurance or cash value life insurance?
How does mortgage protection term insurance differ from other types of term life insurance?
What are the tax issues with life insurance cash values, dividends, and death benefits?
How is universal life insurance different from traditional whole life insurance?
How much life insurance
should you own?
Rough rules of thumb suggest an amount equal to 6 to 8 times your
annual earnings. However, there are other things to consider when determining
how much life insurance you need. Important factors include: income
sources (and amounts) other than salary/earnings; whether or not you're
married and, if so, your spouse's earning capacity; the number of people
who are financially dependent on you; the amount of death benefits payable
from Social Security and from an employer-sponsored life insurance plan,
whether any special life insurance needs exist (e.g., mortgage repayment,
education fund, estate planning need), etc.
What about buying life
insurance for a spouse or children?
Generally, that should not be done in lieu of buying appropriate
amounts of life insurance on the family breadwinner(s). It is extremely
important that you protect the earning capacity of the primary breadwinner,
if possible, with the right amount of life insurance before considering
life insurance on children or spouse. In a dual-income household, it
is important to protect the earning capacity of both spouses. Life insurance
for a non-wage earning spouse is often recommended for help in paying
for household services lost if that spouse dies
Should I buy term insurance or
cash value life insurance?
Term life insurance pays out in the event of death. Cash value,
which is more costly, has a cash amount you can withdraw before death.
Which one is for you will depend on your circumstances. First answer
an insurance question - how much life insurance should you buy? Then
look at the financial aspect - what type of policy should you buy?
The amount of life insurance you need may be so large that the only
way you can afford it is by buying term insurance, which carries a
lower premium than cash value policies. If your ability (and willingness)
to pay life insurance premiums is such that you can afford the desired
amount of life insurance under either type of policy, you can consider
the financial decision - which type of policy to buy. If you view
life insurance as an investment, you'll want to study rates of returns.
If it's protection, then your purchase is a matter of what you can
afford and want to spend.
How does mortgage protection
term insurance differ from other types of term life insurance?
The face amount under mortgage protection term insurance decreases
over time, consistent with the projected annual decreases in the outstanding
balance of a mortgage loan. Mortgage protection policies generally cover
a range of mortgage repayment periods, e.g., 15, 20, 25 or 30 years.
Although the death benefit decreases, the premium is usually level in
amount. Further, the premium payment period often is shorter than the
maximum period of insurance coverage--for example, a 20-year mortgage
protection policy might require that premiums be paid over the first
17 years.
Can an existing life
insurance policy be used to provide for the repayment of an outstanding
mortgage loan?
Yes. Lenders don't usually require that you buy a new mortgage protection
term insurance policy. An existing policy, either term or cash-value
life insurance, can be used for many purposes, including paying off
an outstanding mortgage loan balance in the event of your death.
Credit life insurance is frequently recommended in conjunction with taking out an installment loan when buying expensive appliances or a new car, or for debt consolidation. Is credit life insurance a good buy?
Credit life insurance is frequently more expensive than traditional term life insurance. Further, if you already own a sufficient amount of life insurance to cover your financial needs, including debt repayment, buying credit life insurance is normally not advisable due to its relatively high cost.
What are the tax issues
with life insurance cash values, dividends, and death benefits?
The "interest build-up" portion of the annual increase
in the policy's cash value is not taxed. Dividends generally are considered
to be a "return of premium" and are not taxable. Although
life insurance death proceeds will not typically be subject to income
taxation, they may be subject to federal estate taxation. If you own
part or all of the policy when you die, those can be included in your
gross estate for federal estate tax purposes. State inheritance taxes
and federal gift taxes may also apply to life insurance policies/proceeds
under specific circumstances. Contact your tax adviser regarding questions
about possible income, estate and gift tax consequences surrounding
any life insurance you own or are contemplating buying.
How is universal life
insurance different from traditional whole life insurance?
Both traditional whole life (WL) and universal life (UL) products
are examples of cash-value life insurance. But there are several important
differences between them. One relates to product transparency. In UL
policies, it's easy to look at the internal operations of the policy
and to examine the relationships among various policy elements (premiums,
cash values, interest credits, mortality charges, and expenses) and
how they interact with each other. Another difference is that unlike
whole life policies, universal life policy returns were freed from long-term,
fixed-rate contracts and replaced with policies whose returns were tied
to short-term interest rates and periodically adjusted. After the initial
payment, universal life allows you to pay premiums anytime, in virtually
any amount, subject to certain minimums and maximums. You can also reduce
or increase the amount of the death benefit more easily than under a
traditional whole life policy.
Which type of cash
value life insurance policy, universal life (UL) or participating whole
life (WL), is a "better buy" financially?
There's no simple answer to this. The best performing product (from
a financial perspective), whether UL, WL or some other type of cash
value life insurance, will likely be the one that reveals the most favorable
interest earnings, actual expenses and mortality costs. Insurers earning
the highest investment income, and who also incur the lowest expenses
and the lowest mortality costs, are in the best position to offer life
insurance at the lowest cost. This is true whether the cash value product
being offered is UL or WL. You and your adviser should carefully examine
the financial aspects of each product under consideration.
What is variable life
(VL) insurance, and how is it different from universal life (UL) and
participating whole life (WL)?
Variable life insurance is a type of fixed-premium whole life insurance
policy where changes in the policy's cash values and death benefits
are directly related to the investment performance of its underlying
assets. Policy owners typically can choose among several investment
options for the assets backing the policy's cash values. The various
investment options offered in the contract generally possess different
risk/return relationships and frequently include a money market fund,
a bond fund, and one or more common stock funds. The policy prescribes
that the death benefit will not fall below a minimum amount (usually
the initial face amount) even if the invested assets depreciate in value
by a substantial amount. Because the policy owner assumes all of the
investment risk, there is no similar "floor" to protect the
cash values. Variable universal life (VUL) insurance has recently become
a more popular product than VL. VUL combines features of both UL and
VL and, in essence, is the flexible premium version of VL.
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