As we grow older, get married, and start a family, our priorities shift. We are no longer just responsible for our own well-being. We are also responsible for our spouses and our children. Often we overlook how to best protect our family because we are focused on producing income to manage day to day life. One priority which should take center stage is how to protect your family when you are gone. This is done through obtaining life insurance.
Life insurance is a contract between the insured (you) and the insurer (insurance company). The insurer promises to pay the beneficiaries (your family) a designated sum of money, called a death benefit, upon the death of the insured. The insurer pays the benefit in exchange for a premium paid over the term of the policy. Most, if not all policies, will surrender (cancel) if you don’t pay your premiums. Most companies break down each policy based on rate class, which identifies the insured based on their overall health. Insurance companies typically will require a physical to help them identify your rate class.
The most common rate classes are as follows:
– Preferred Plus – This is the best rate class and will get you the best rate. It is for non-smokers, no serious medical issues, good overall physical health
– Preferred – this assumes no smoking in the last 3 years or more with above average overall health.
– Select – assumes you haven’t smoked recently, your health is good, and your vitals are average.
– Standard – this assumes you have smoked recently, but you still have good overall health.
– Non-Standard – this assumes you have a chronic pre-existing condition, such as diabetes or heart disease. This policy can be very expensive depending on the insurer. Some won’t even consider anything below standard. Here are the basic forms of life insurance and how they work.
A term policy is the cheapest form of life insurance. It provides coverage for a fixed rate over a specified term. Those terms are commonly 10, 20, and 30 years. When the term ends, the policy becomes void or the insured can extend it, but usually at a different rate and term based on health and age. It is basically a risk management tool. You pay your premium for the entire term. If you pass away during the term, then the insurer pays out the benefit. If you outlive the term of the policy, then the premiums you paid are not refunded to you. For this reason, term life is the most cost effective form of life insurance.
Whole life is a form of permanent life insurance where the policy is in effect until age 100 or until the insured passes away, whichever comes first. In addition to the death benefit, permanent life insurance policies such as whole life also have a cash value component. Cash value is the amount of the premium above the cost of insurance, which is typically the premium amount for a term policy. The cash value amount is then invested by the insurance company on behalf of the policy owner. In a whole life policy, the cash value is invested primarily in bonds. The earnings on the cash value grow tax-deferred. Whole life policies tend to have high costs associated, mainly around agent commissions and investment management fees. Many whole life policies can have high upfront costs, which make it harder to start earning an investment return. According to James Hunt, an actuary at the Consumer Federation of America, one would need to keep their whole life policy in effect for at least 20 years before they see a decent return. With an annualized rate of inflation around 3%, you can expect to only earn near 1 – 2% on a whole life policy.
Variable Universal Life
Variable universal life insurance (VUL) is another form of permanent insurance. Where the premiums on a whole life policy are fixed, with a VUL the premiums are flexible. Also, in contrast to a whole life policy where you can’t direct how the premiums are invested, a VUL allows you to allocate premiums (above the cost of insurance) into subaccounts that are invested in equity funds, bond funds, or money market funds. Based on the selection of the subaccounts, the cash value can fluctuate depending on the investment returns. VULs also have an option that can be selected when the policy is issued where the death benefit can increase over time based on the investment return or stay fixed.
Below is an estimate of where costs can start for the above life insurance products. These quotes are for a 30 year old male with a preferred rate class. The coverage is for $250,000.
– 30-Year Term Life – $27.45 per month.
– Whole Life – $173.00 per month
– Variable Universal Life – $127.00 per month
The key to understanding life insurance is to find what you need and what you can afford. Term life insurance is by far the most cost effective insurance policy for most people. A key to remember is most insurance agents are pushed to offer permanent life insurance. This pays them a higher commission and makes the company more money over time. Don’t get caught up in the hype of whole and variable life insurance. Make sure you understand all of the aspects before jumping into the higher priced policies. If you like the cash-value aspect, then look into how much you can make just investing the difference between a term and permanent policy on your own.
There are a large number of insurance companies offering life insurance, so it is important to compare rates and coverages. If you log into iQuantifi we will tell you what type of policy and how much insurance you should have based on several variables (income, debt, family status, age, etc.) You can also compare coverages and see your options at LifeHappens.org, but they won’t tell you how much insurance you should have.
By Grayson Bell, Staff Writer