Understanding Life Insurance: Typical Division Of Benefits

Life insurance is a contract between a policyholder and an insurance company that pays out a death benefit when the insured person passes away. There are two main types of life insurance: term and permanent. Term life insurance provides coverage for a set number of years, while permanent life insurance provides coverage for the rest of the insured's life. Permanent life insurance policies often include a cash value component, which allows the policyholder to access a portion of the death benefit during their lifetime. This is known as a living benefit. Living benefits can provide financial resources during the policyholder's lifetime, such as in the case of a chronic or critical illness. While term life insurance is generally more affordable, permanent life insurance offers the advantage of lifelong coverage and the potential for living benefits.

Living benefit riders

There are two main types of living benefit riders: cash value and living benefit riders. Cash value accounts grow over time and can be accessed through withdrawals or secured loans. Permanent policies often come with cash value components, which you can withdraw from or borrow against.

• Terminal illness rider: Allows you to withdraw some or all of your death benefit if you're diagnosed with a terminal illness and have a limited life expectancy (e.g. 12 months or less).
• Chronic illness rider: Allows you to withdraw a portion of your death benefit if you're diagnosed with a chronic illness and are unable to perform a certain number of activities of daily living.
• Critical illness rider: Similar to the chronic illness rider, but applies to a specific list of critical illnesses such as strokes, heart attacks, kidney failure, paralysis, and cancer.
• Long-term care rider: Allows you to use your policy's death benefit to pay for long-term care expenses such as home health care services, fees for assisted living facilities or nursing homes, and costs to pay friends or family members who provide care.
• Disability waiver of premium rider: If you become totally disabled, this rider waives your premiums, allowing you to maintain life insurance coverage without making additional payments.

Cash value accounts

When you pay your premium, a portion goes towards funding the policy's cash value. This cash value earns interest over time at either a fixed or variable rate, depending on the type of permanent policy you have. Once you've accumulated enough cash value, you can access this money in several ways:

• Withdrawals: You can make partial or full withdrawals from your cash value. However, if you withdraw more than you've paid into the account, that portion will be taxed as ordinary income. Withdrawals will also reduce the death benefit paid out to your beneficiaries.
• Loans: You can borrow against your cash value and use the money for any purpose. You'll have to repay the loan with interest, and if you don't, the outstanding amount will be deducted from the death benefit.
• Premium payments: You may be able to use your cash value to pay your insurance premiums.
• Surrender: You can cancel your policy and take the "surrender value", which is the cash value minus any surrender charge. This will terminate the policy and your insurance coverage.

It's important to note that it can take several years for your cash value account to accumulate a significant balance. Additionally, cash value life insurance policies tend to have higher premiums than term life insurance policies. While term life insurance is generally more affordable, it doesn't offer the same savings component or lifelong coverage as permanent policies.

Permanent life insurance

There are two primary types of permanent life insurance: whole life and universal life. The cash value of whole life insurance grows at a guaranteed rate. Universal life insurance also contains savings and a death benefit, but it features more flexible premium payment options, and its earnings are based on market interest rates. Variable life and variable universal life provide expanded options to invest the cash value in mutual funds and other financial instruments.

The cash value of a permanent life insurance policy can be accessed in several ways. The policy owner can borrow against it, surrender the policy before death to collect the savings, use the cash value to pay premiums, or ask the insurer to transfer the cash value to the death benefit.

The main differences between permanent policies lie in their potential to build cash value and how they earn interest. Permanent life insurance is ideal for those seeking protection and coverage without a specific endpoint, such as families, businesses, and individuals with high net worth.

Term life insurance

There are several types of term life insurance policies, including:

• Level term or level-premium policy: the most common type of policy, where the premium remains the same for the entire term.
• Yearly renewable term policy: a one-year policy that can be renewed annually without a medical exam but at a higher cost.
• Return of premium: a type of policy that pays back all or a portion of the premiums if the policyholder survives the term. However, these policies tend to have much higher premiums.
• Guaranteed issue: these policies do not require a medical exam, but the premiums are much higher as the insurance company assumes the policyholder is a risky prospect.
• Convertible term life insurance: a term life policy that includes a conversion rider, allowing the policyholder to convert an in-force term policy to a permanent plan without undergoing underwriting again.

The cost of term life insurance is based on several factors, including the policy's value, the policyholder's age, gender, and health. The insurance company will also consider its business expenses, investment earnings, and mortality rates for each age when setting premiums. Term life insurance is usually the least expensive type of life insurance because it offers a death benefit for a restricted time and does not have a cash value component.

Whole life insurance

In addition to a guaranteed death benefit for your beneficiaries, whole life insurance can help you build cash value, which accrues interest over time. You may tap into the cash value while you’re still alive through a withdrawal, loan, or by surrendering the policy. Interest is charged on policy loans with rates varying per insurer, but the rates are generally lower than you’d get with a personal loan or home equity loan.

Frequently asked questions