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Investing in something that pays you back for dropping dead sounds pretty depressing to most folks. That’s why the whole subject of life insurance strikes most people as rather unpleasant and leads them to postpone any meaningful discussion of it, if possible. There’s an old saying that you cannot avoid death and taxes, but that doesn’t mean you can’t avoid thinking about them or talking about them. With that in mind, it’s understandable that the majority of Americans don’t have any life insurance coverage. After all, if you don’t want to bring life insurance up in conversation, you probably won’t learn whether or not it has anything to offer you – and you won’t have an incentive to buy it. Before you can figure out whether or not you want to invest in life insurance, in other words, you first have to figure out just what it’s all about and what benefits it’s supposed to provide to you and your loved ones.
There are different types of life insurance products that each have their own names or terminology, which is why an overview of those categories seems like the right place to begin. To start, there are two types of life insurance; term life and cash-value life (more on those two later). Let’s dive right in and see what the below terms mean when dealing with life insurance.
Term Life is most likely the first term to come to mind for those who aren’t too familiar with the nuances of life insurance. Term Life insurance is meant to provide money to your loved ones or other designated beneficiaries upon your death. The policy pays at face value, so if you have a $1 million policy, your survivors are entitled to $1 million.
When you buy Term Life, it only insures you for a specific amount of time, or a maximum term. Usually the longest term you can purchase is about 30 years. These policies are often the least expensive, too, which means they deliver higher coverage amounts per dollar spent on the premiums.
If you’re young and healthy your premiums will naturally be lower because, according to statistics, you have a better chance of outliving your policy. Conversely, the older you get the more you can expect to pay for your Term Life policy. Hey, it’s simple economics and business calculus. If insurers sold dirt cheap policies to people who were really old and not expected to live much longer they’d sell a lot more insurance, but would soon go broke.
One of the big factors that sets Whole Life apart from the more simple and straightforward Term Life is that a Whole Life policy guarantees to keep you covered no matter how long you live. So, you don’t have to worry about your term running out prematurely. Another characteristic of Whole Life is that this kind of life insurance also allows for some growth of the cash value of the policy on a tax-deferred basis.
Generally speaking, the interest you earn is low, so the growth won’t be very aggressive. Each time you make a premium payment however, a portion of that payment is applied to the cash value that accumulates in your insurance account. You can borrow against that value, too, although if you need to withdraw, it will be treated like a loan. You’ll have to pay interest on it, and any outstanding balances of withdrawn amounts will be deducted from the payout of death benefits. For example, if your total value is $150,000 and you withdraw $30,000 then the death benefit level drops to $120,000.
Universal Life insurance is another product that insures you for your entire life, and it also allows for the accrual of cash value as your account earns interest over time. The main distinction here is that the policyholder has the option to adjust their levels of coverage along the way. So if you reach a point where you would like to raise your coverage, you can. On the other hand, maybe you want to lower the cost of your premiums, and in that case, you can opt for lower coverage to make your life insurance easier on your budget.
Variable Life is life insurance that combines some features of Whole Life with the opportunity for greater value growth through investing in such things as stocks and bonds. The portion of your insurance premium that is allocated to investment goes into a portfolio of investment funds managed by your insurance company. Since stock and bond investments are subject to value fluctuation as the stock and bond markets go up and down, that change can alter the value of your available cash and your death benefits. That’s why they call this kind of insurance “variable.” You have the opportunity for more robust cash value growth, but you also run the risk that your value will fall.
If you encounter the term “Annual Renewable” and “Convertible Term,” it means that the life insurance only covers you for one year – but that you have the option to renew the policy without having to submit new documentation. In exchange for this flexibility, your premiums will get gradually more expensive each time you renew. “Decreasing Term Policy,” on the other hand, guarantees that your premiums stay fixed without raising, but the older you get the more the death benefits shrink.
Lots of people use Decreasing Term insurance to protect their heirs from mortgage debt. The more payments you make on your home loan the more the mortgage balance goes down. Meanwhile, the longer you have your Decreasing Term insurance the more your death benefit decreases, so the changes can offset one another without leaving you short on insurance coverage.