No one lives forever. Yet ownership of life insurance — to protect our loved ones when we die — has fallen in the U.S. to a 50-year low, according to the most recent research from LIMRA, a nonprofit life insurance industry group. Thirty percent of U.S. households have no life insurance at all.
“People often don’t want to do the hard analysis it takes to figure out how much money their families will need if they die,” says Steven Weisbart, chief economist with the Insurance Information Institute, an industry trade group.
“It takes real work to distinguish between the many policies and companies,” he adds. “People end up not buying anything because it’s so overwhelming.”
Variable. Universal. Permanent. Whole life. There’s a bewildering range of choices. But life insurance doesn’t have to be a headache.
The most important thing is that a policy should be large enough to pay for the insured person’s funeral expenses and outstanding medical bills, take care of outstanding debts, and meet long-term goals such as children’s college tuition, says Brad Huffman, a Certified Financial Planner with Future Finances Inc. in Worthington, Ohio. “The policy should also cover lost income, multiplied by the number of working years left before retirement.”
Life insurance falls into two main categories: term, with coverage lasting for a set number of years, then expiring; and permanent, which doesn’t expire as long as premiums are paid.
For most people, what’s called level term life insurance is the best fit, says Marvin Feldman, president of the LIFE Foundation, a nonprofit insurance education group. “It works for everybody. It has the highest death benefit for the lowest premiums. It should be the default choice.”
The premiums and the death benefit are what’s “level” — they stay the same over the life of the policy, unlike other term insurance with premiums that increase over time, Feldman says. The term is the amount of time the policy is in effect, usually 10-30 years. If death occurs during the term, level term typically pays the death benefit as a lump sum.
There are other flavors of term. Decreasing term life insurance has a death benefit that slowly declines over the life of the policy. These are often used to cover debts such as a mortgage, which also would decrease over time, Feldman says. Return-of-premium term policies will refund all of the premiums paid if the insurance person doesn’t die before the end of the term. These policies cost up to 50 percent more.
A convertible level term policy is one that can be changed into permanent life insurance when it expires, regardless of the insured person’s current health, Feldman says. Some term policies automatically include a convertible option. Others sell it as a rider, or add-on.
Permanent life insurance policies can be more complicated and expensive than term. They pay out a death benefit, called a “face value.” They also accumulate a tax-deferred “cash value” balance, which can be used to pay premiums or can be cashed out if the policy is canceled. Policyholders also may take out loans against the money.
“Permanent policies cost significantly more because they’re building a cash value, and the policy normally lasts longer,” says Feldman.
Whole life is the simplest type of permanent life insurance. Premiums never increase, the policies build a modest cash value, and the death benefit doesn’t change, Feldman says.
Universal life is another, more flexible type of permanent policy, allowing the policyholder to increase or decrease the death benefit at any time, and decide how much or little to pay in premiums, within limits set by the company. The policies often cost less than whole life.
Also, with universal life, the insurance company invests a portion of the premiums in securities. If the investments do well, the cash balance grows and can pay the premiums and fees, Weisbart says. But if the investments lose money, you may have to pay more into the policy to keep it from being canceled.
Variable life insurance policies are premium policies that let the policyholder, not the insurance company, decide how the premiums are invested.The premiums hold steady while the death benefit and cash value fluctuate along with the financial markets. “You choose the investments,” usually stocks, bonds and mutual funds, Feldman says, “but the underlying product is only as good as your market acumen.”
Gains are tax-deferred and, upon death, are paid out as a death benefit not subject to income tax, Huffman says. If the investments do poorly, the cash value and death benefit decrease. These policies usually have lower returns than other investments, after accounting for fees.
Yet another option is variable universal life insurance, which has characteristics of both variable and universal policies. As with variable life insurance, variable universal gives the ability to invest premiums in securities of your choosing; like universal, it provides more flexibility and control over the death benefit amount and the premiums paid into the account.
Universal, variable and variable universal life policies aren’t the right choice for most people, Weisbart says. “These products are riskier than term because you’re hitching your death benefit to the performance of the stock market.”
They’re frequently used by wealthier families to hedge against the estate tax, Huffman explains. “The death benefit is used to provide liquidity to heirs, so they can pay the tax bills.”
For most people, the death benefit should be the main factor in choosing life insurance, rather than the lure of investment returns, Weisbart advises. “Buy the policy with the death benefit large enough to do what needs to be done. It’s the only way to be sure you won’t be underinsured.”