In this second part of our four part series, we explain the complex differences between different kinds of life insurance and discuss why purchasers need to understand them.
In Part 1 of this series, we provided an overall summary of life insurance and why it is an important part of any financial plan, particularly for physicians who either have a family or plan to start one. Today, we’ll look at the different main categories of life insurance.
Keep in mind that the types of life insurance described here are general; each of the categories below includes several sub-types, with variations from product to product. Also, different life insurance providers call each of these types of life insurance by different names. This lack of standardization and the overall variability in the features of life insurance policies often contributes to what many consider unnecessary complexity. In general, though, you will have a choice among these basic types of policies.
Types of Life Insurance
Term Life Insurance
Term insurance is the most basic and is typically the least expensive form of life insurance for people under the age of 50. A term policy is written for a specific period of time, typically 1 to 10 years, and may be renewable at the end of each term. One not-so-attractive feature of term insurance is that the premiums will likely increase at the end of each term and can become prohibitively expensive for older individuals.
Whole Life Insurance
Whole life policies combine permanent protection with a savings component. As long as you continue to pay the premiums, you are able to lock in coverage at a level premium rate. Part of the premium you pay accrues as cash value. As the policy increases in value, some plans allow you to borrow a portion of its cash value without facing any tax liability, although such loans are subject to some restrictions and may trigger a taxable event if the policy lapses. There are many more variables associated with whole life insurance than there are for term life insurance.
Universal Life Insurance
Now we’re starting to get into the policies that add the most variation and, thus, often the most confusion. Universal life insurance is similar to whole life, with the added benefit of potentially higher earnings on the savings component. Universal life policies are also more flexible in regard to premiums, face value, and the options for withdrawing cash. Universal life policies typically offer a guaranteed return on cash value. Here is where you’ll often see the language, “All guarantees are based on the claims-paying ability of the insurer.” Put simply, that means that if the company providing the insurance goes belly-up, there is no government source or secondary provider to follow through on that guarantee. This is part of the reason that companies with strong brands and long legacies tend to dominate this competitive landscape.
Variable Life Insurance
Variable insurance generally offers fixed premiums and the ability to invest your cash value in a choice of stock, bond, or money market-based investment options offered by your insurer. Variable life policies are the point at which a protection and savings vehicle can turn into an investment vehicle. This sounds risky to many people who are uncomfortable tying the protection and future of their family members to the performance of stocks and bonds. Indeed, cash values and death benefits for variable life policies can fluctuate with the performance of your investment choices, and even the principal of your investment is at risk. Fees are also higher for many variable life plans, in part because the investments in these policies are typically actively managed by a professional.
How to Choose
Deciding from among these types of life insurance is no simple task. For those reasons, you’ll want to work with a trusted advisor who can help you sort through not just the types of policies available to you, but the features, potential benefits, and drawbacks of each of those plans.
In Part 3, we’ll look at the components of a life insurance policy you may be most interested in, which will help you determine what kind of policy you should zero in on.