Estate Planning: Life Insurance

When it comes to life insurance, there are many choices: Whole life. Variable universal life. Term. What do these descriptions really mean?

All life insurance policies have two things in common: They guarantee that they will pay a death benefit to a designated beneficiary after a policyholder dies (although the guarantee may be waived if the death is a suicide occurring within two years of the policy purchase). All require recurring payments (premiums) to keep the policy in force. Beyond those basics, the differences begin.

Some life insurance coverage is permanent; some not. Permanent life insurance is designed to cover you for your entire life, not just a portion, or "term," of it, and it can become an important element in your retirement planning. Whole life insurance is its most common form.

Whole life policies accumulate cash value. How does that happen?

An insurer directs some of your premium payments into a reserve account and puts those dollars into investments, typically more conservative ones. The return on the investments influences the growth of the cash value, which builds up according to a formula the insurer sets.

A whole life policy's cash value grows with taxes deferred.

After a while, you gain the ability to borrow against that cash value. You can even cancel the policy and receive a surrender value. Premiums on whole life policies, though, are usually higher than premiums on term life policies, and they may rise with time. Beneficiaries can only receive a death benefit and not the policy's cash value when a whole life policyholder dies.

Universal life insurance is whole life insurance with a key difference.

Universal life policies also build cash value with taxes deferred, but there is the chance to eventually pay the monthly premiums out of the policy's investment portion.

Month by month, some of your premium on a universal life policy gets credited to the cash reserve of the policy. Sooner or later, you may elect to pay premiums out of the cash reserve, so the policy essentially begins to pay for itself. If all goes well, a universal life policy may have a lower net cost than a whole life policy. However, if the investments the insurer chooses severely underperform, that can create an issue with the payment of the policy. If the cash reserves dwindle enough, the policy could end up being accidentally canceled if the premiums aren't paid.

What about variable life (VL) and variable universal life (VUL) policies?

VL policies are whole life or universal life policies with a riskier investment component. In VL and VUL policies, you may direct percentages of the cash reserve into investment subaccounts managed by the insurer. Assets allocated to the subaccounts may be put into equity investments of your choice as well as fixed-income investments.

Term life insurance is life insurance that you "rent" rather than own.

It provides coverage for a set period, usually 10 to 30 years. Should you die within that period, your beneficiary will get a death benefit. Typically, the premium payments and death benefit on a term policy are fixed from the start, and the premiums are much lower than those of permanent life policies. When the term of coverage ends, you may be offered the option to renew the coverage for another term or to convert the policy to a form of permanent life insurance.

Term life is cheap, but the trade-off comes when the term is up. Just as you cannot build up home equity by renting, you cannot build up cash value by renting life insurance. When the term of coverage is over, you usually walk away with nothing for the premiums you have paid.

Which coverage is right for you?

Many factors may come into play when you are deciding which type of life insurance will suit your needs. The best thing to do is to speak with us and we can help you examine these factors so you can determine which type of coverage you should have.