Life Insurance Accumulation: A Long-Term Financial Strategy

Life insurance is a difficult topic. While most people recognize its value, many are unsure about which type is best for them. Whole life insurance is permanent life insurance that guarantees coverage for the entirety of the insured person's life, as long as premiums are paid. It is more expensive than term life insurance, which only covers a specific term, such as 10 or 20 years, and does not accumulate cash value. Whole life insurance policies have a savings component, known as the cash value, which can be withdrawn or borrowed against. This cash value grows over time and is an essential feature of whole life insurance.

Whole life insurance

There are several payment types for whole life insurance policies:

• Regular payments: Fixed amounts paid monthly, quarterly, semi-annually, or annually.
• Single premium: The entire cost of the policy is paid upfront, and no further premiums are required.
• Limited payment: Regular premiums are paid for a set number of years, after which no more payments are required.
• Modified premium: Premiums are lower for a set number of years, typically the first three to five, and then increase for the remainder of the policy.

Universal life insurance

One of the main advantages of universal life insurance is its flexibility. Policyholders can adjust their premiums and death benefits to suit their changing needs and income. The death benefit can be increased, although this may require a medical exam. The cash value of the policy can be accessed through loans or partial withdrawals, and the interest rates on these loans are often lower than personal loan rates.

However, there are also some disadvantages to consider. The returns on the cash value are not guaranteed and can be affected by interest rate changes. While there are no tax implications for borrowing against the cash value, some withdrawals may be taxed. Additionally, if the cash value is not carefully monitored, the policy may become underfunded, leading to large payment requirements or policy lapse.

Compared to whole life insurance, universal life insurance offers more flexibility in terms of premium payments and death benefits. Whole life insurance has fixed premiums and a guaranteed death benefit, whereas universal life insurance allows for adjustments. Universal life insurance generally offers lower premiums than whole life insurance, but the death benefit and cash value growth are not guaranteed.

Variable universal life insurance

However, variable universal life insurance does come with risks and drawbacks. The return on your cash value is not guaranteed and you could lose money. If your cash value balance is too low, you may need to pay higher premiums to keep your policy. Variable universal life insurance can also charge high fees because you are paying for both life insurance and investments.

Term life insurance

When you buy a term life insurance policy, the insurance company determines the premium based on the policy's value (the payout amount) and factors such as age, gender, and health. The premium is usually fixed for the duration of the policy. Other considerations affecting rates include the company's business expenses, investment earnings, and mortality rates for each age. In some cases, a medical exam may be required, and the insurance company may inquire about your driving record, current medications, smoking status, occupation, hobbies, and family history.

If you die during the policy term, the insurer will pay the policy's face value to your beneficiaries. This cash benefit is typically not taxable and can be used to settle healthcare and funeral costs, consumer debt, mortgage debt, and other expenses. However, beneficiaries are not required to use the insurance proceeds to pay off the deceased's debts.

When a term life insurance policy expires, it typically ends without any action needed from the policyholder. The insurance carrier sends a notice, premiums stop, and there is no longer a death benefit. Some term policies offer the option to renew annually after the initial term expires, but at a higher cost due to age-related risk increases. Additionally, some term policies include a conversion rider, allowing you to change your term policy into a permanent one without a medical exam.

Cash value

When you make a premium payment for a cash value life insurance policy, only a portion of it goes into the policy's cash value. The rest covers the insurer's cost of providing the death benefit and their fees and charges. The cash value component typically earns interest or investment gains and grows tax-deferred.

Accessing Cash Value

There are several ways to access the cash value of a life insurance policy:

• Loans: You can borrow against the cash value of a permanent life insurance policy. The loan amount accrues interest until it is paid back in full.
• Withdrawals: You can withdraw money from the cash value. However, if the withdrawal includes investment gains, this portion is typically taxable as income. Withdrawals also reduce the future life insurance payout to beneficiaries.
• Surrendering the policy: If you cancel the policy, you can receive the cash value minus any surrender charges, unpaid premiums, or outstanding loan balances.

Types of Cash Value Life Insurance

There are several types of life insurance policies that offer a cash value component:

• Whole Life Insurance: This type of policy offers a fixed monthly premium, a fixed rate of growth for cash value, and a guaranteed death benefit amount. Whole life insurance is typically more expensive than other options due to these guarantees.
• Guaranteed Issue Life Insurance: This is a type of whole life insurance that does not require a medical exam or health questions. The coverage amounts are generally small, resulting in a smaller potential cash value.
• Guaranteed Universal Life Insurance: This type of universal life insurance has fixed premium and death benefit amounts, with minimal cash value accumulation.
• Indexed Universal Life Insurance: The cash value growth of this policy is tied to the performance of an index, such as the S&P 500. Policyholders can adjust premiums and death benefits within certain parameters.
• Variable Universal Life Insurance: The cash value growth of this policy is tied to sub-accounts containing investments chosen by the policyholder, such as bonds and mutual funds. This option offers the potential for higher returns but also carries the risk of losing money based on investment performance.

Benefits of Cash Value Life Insurance

• Lifelong coverage: Cash value life insurance provides permanent coverage, meaning it lasts your entire life as long as premiums are paid.
• Flexible access to funds: Policyholders can access the cash value during their lifetime, providing financial flexibility.
• Reasonable premiums: Although premiums for cash value policies may be higher than term life insurance, they can still be affordable and fit within your budget.

Considerations for Cash Value Life Insurance

When deciding if cash value life insurance is right for you, consider the following:

• Need for lifelong coverage: If you only need short-term coverage, another policy like term life insurance may be a better option.
• Desire for a cash value component: Consider whether you want to build wealth and have the ability to withdraw or borrow from your policy.
• Comparison of quotes and policies: It is important to compare quotes and policies from different companies to ensure you are getting the coverage that best suits your needs and goals.

Frequently asked questions