Introduction
We’re going to talk about the three most common types of life insurance. I know that can be pretty dry, but because everyone has a different situation, one policy may be more favorable than another. As your situation and your finances change, evolving into other types of policies could make financial sense. Now, in subsequent videos, we’re going to dissect the purpose, use, and advantages of using permanent or high cash-value type insurance, so stay tuned.
1-Term Life Insurance
Alright, so here we go. To start, let’s look at the most common type of life insurance, which would be term. Why is the term the most common? Well, for one, it’s the least expensive pure life insurance death benefit. It can be used to protect your family, to pay off debts, and maybe even to pay for planned future expenses. It may not be good for a lifelong policy, however.
The Downside of Term Life Insurance
You can buy term for specific periods such as 5, 10, 15, 20, or even 30 years, and the downside to term is this: it gets more expensive as you age. It’s prohibitive for estate planning as the older you get, premiums can be far too expensive. Most people drop their term coverage about retirement time as the costs are pricing them out of their policy. The term has no return of premium or cash value. Once you quit paying premiums, all past premiums are lost. They’re gone. You essentially must die to get a benefit.
When to Use It
Now, you never own term insurance. It’s more like renting. You quit paying rent, you don’t have anything to show for it. So, when do you want to use term insurance? Well, one of the most popular reasons is when you’re young it’s inexpensive, and you have a young family. The term can be a great way to ensure your family will be provided for in case of a tragedy or an end-time death.
The Payouts
Only about one to two percent of all term policies ever end up paying a death benefit, which is why it’s relatively inexpensive. The chances of a young 20, 30, or 40-year-old dying are in the company’s favor. By the time you hit your 60s and 70s, the term is extremely expensive and is usually dropped because of the costs, or it’s not available because of health issues.
2- Universal Life Insurance
The next type is what’s called a Universal Life. Universal Life came out in about the 80s. It was designed to build some cash value and help offset the cost of insurance as you age. Essentially, the premium is made up of two parts: you have the insurance part for the death benefit, and then there’s a savings part or a cash value part. The death benefit in a UL is covered by, guess what, term insurance and it’s not the cheap term insurance you hear advertised on the radio. It’s quite an expensive term insurance.
The Structure of Universal Life Insurance
The difference is, you can buy term in increments like, you know, 10, or 20, or 30 years. In a UL or Universal Life, the term is what’s called the Annual Renewable Term. It’s less costly while you’re young, but it is incredibly expensive as you age. The idea with the UL is that you overpay the premium, and the excess goes into a cash value account, and those funds receive what’s called an interest credit based on the current interest rates at the time. The hope was the cash value would grow, and as the cost of the term insurance increased, the cash value could help offset those costs. If there was enough cash value at some point, the earnings on the cash value would, or hopefully could, help pay the premiums.
The Downside of Universal Life Insurance
The downside was, again, the cost of insurance. It had no cap to it. In other words, the insurance company could raise the term cost, and for many, the cash value was eaten up rather quickly, and by the time people retired, the cost of insurance had escalated. The cash value couldn’t keep up with the costs. Now, when that occurs, you’re faced with either paying the premium out-of-pocket, which is huge, or the policy lapses, and you lose everything. Many older couples could not afford the higher premiums, and those policies lapsed.
Types of Universal Life Insurance
Now, there are three types of UL or Universal Life: there’s a Fixed Universal Life, a Variable Universal Life, and an Indexed Universal Life.
Fixed Universal Life Insurance
Universal Life, a fixed UL, interest rate-driven. Each year it’s credited an interest rate and it’s adjusted based on the current economic environment. As you can imagine, with interest rates where they are currently, this type of Universal Life is very unattractive as the costs are much higher than even the potential earnings.
Variable Universal Life Insurance
The second type, or the Variable, or the VUL Universal Life, this type of UL took the cash value and essentially let you invest it in mutual funds, which were called sub-accounts. The two problems with a Variable are: that the risk of the market is all on you, and if there are losses, they directly impact your cash value. Secondly, the management fees charged for a Variable policy are horrendous. It’s not uncommon to have three to five percent each year just in fees, and this can eat up cash value and potential returns quickly. If you have losses and also subtract fees and the cost of insurance, many of these policies in a market downturn turn out to be a disaster.
Now, the final piece to a Variable UL is it still uses term insurance as the death benefit, and again, each year it’s more expensive. And the older you get, the worse it gets. Couple that with market volatility in my opinion, the VUL can be one of the riskiest policies you can get.
Indexed Universal Life Insurance
The last type of UL is called an Indexed Universal Life, or an IUL. This is relatively new; the first ones were issued in 1997. We’ve yet to see a full generation go with this type of policy, but the premise is, it’s still a UL. It’s still term insurance and a cash value component. The difference is how the cash value is credited. The insurance company takes a portion of the interest it earns on its portfolio and it buys options on an index such as the S&P500. The idea is that you can participate if the market goes up, but if the market goes down, you can’t lose any money as you could in a VUL.
Your money isn’t in the market is the reason why your money doesn’t go down when the markets do. You just participate via the option. In an IUL, we still have the issue of term insurance and the escalating costs. Even in a year where the market goes down and your cash value isn’t affected due to market losses. You still have the cost of insurance coming out, and the fees. And again, this isn’t the cheap term that you can just go buy with an ad on TV. It’s very expensive term. When the cost of the term comes out of your premium, you still end up going backward because the VAT cash value did not grow that year, but your cost still came out.
The Problem with Indexed Universal Life Insurance
The real problem with an IUL is the ridiculous market return projections that many agents use. You should never trust an illustration that shows more than about 4%, but so many of them are still using 6, 7, 8, and 9%. Those returns are fictitious and unlikely to even come close to that kind of a return.
3- Whole Life Insurance
Now, the final type of insurance is called Whole Life. Now, Whole Life is the oldest of all insurance. It’s pushing about 200 years in longevity, and it even goes back further. I’d say the biggest difference is, you can own a Whole Life policy. You can pay it up, kind of like paying off your mortgage, and then you own the policy. The other difference is how the insurance is paid for. With each premium, you own more and more of your death benefit. It’s not term insurance. It’s the only policy that isn’t term insurance. The cost of the insurance is more expensive than term, and it’s priced so that you will have it your whole life. It’s not made for short-term needs. It’s made to die with it, no matter how old you are.
Very efficient lifelong policy
Most Whole Life policies are designed to be owned at some point, in many cases, that’s about the time you retire. This way, you can quit paying premiums, yet you still have your policy growing and compounding. The death benefit is owned, and the cost of insurance is eliminated. This makes for a very efficient lifelong policy.
The downside
The downside is that it’s not made to be a short-term vehicle. The efficiency comes the longer you own it. The cash value grows by way of the dividend. Now, this varies between companies, but the dividend can also be used for a tax-free income stream during retirement.
The Cost of Whole Life Insurance
The cost of insurance in a Whole Life policy is spread out throughout your whole life. It never gets any more expensive. Remember, in any of the ULs, because it’s Annual Renewable Term insurance, every year the cost of insurance gets higher. The older you get, the more gray hair you get, the worse it’s going to be. Whole Life never changes. If you buy a policy at 25 years old and you’re now 80 years old, your cost of insurance doesn’t change. It’s still as if you’re 25 years old.
The Benefits of Owning a Whole Life
So, it’s again designed just a lot differently, and more importantly, it’s designed so that you can own it. And owning your policy can be huge in retirement. You know, one of the most efficient ways to pass on an estate is through life insurance. However, you’ve got to plan for that ten, fifteen, twenty years before retirement, so that you can get a policy paid up, and so that that can be again one of the most efficient ways to pass on your legacy.
When to Use Whole Life Insurance
Whole Life is not made for short-term needs. That’s for term. If you just need to cover something for the next five to ten years, some kind of a debt, or to make sure that something gets paid for if you were to die, then the term is exactly what you want. And again, for most young couples, term is the way to start. Once you can save and put away some more money, then Whole Life can make a lot of sense.
The Risks of Universal Life
In my opinion, Universal Life is a little bit too dangerous to even mess with. The reason is that the cost of insurance is going to continually escalate. You can never own it, and chances are, you could be priced out of that policy before you finally pass on.