Here is probably the most controversial subject in life insurance. Because there is a big conflict of interest coming from the people selling those products. It is really important to understand the difference between the 3 major life insurance category, in order to better use them, to get properly protected and to pay the lower premium possible. First, I’m going to describe them to you, then how to use them.
This type of insurance has been around since the beginning of earth. It is the most commonly seen life insurance type in the market, even though the trend seems to change since a couple of years. Basically, you have a fixed capital amount (let’s say 100,000$) and a fixed premium (60$) for as long as you live (maximum 100 years old). You also accumulate cash values that grow slowly into your policy. Usually, those cash values are not redeemable for the first years (10 to 20 years) of your contract. After those years, if you choose to take some money out of your cash values, you will have to pay it back and will be charged an interest rate just like a loan because it is one.
The part where it gets ugly, is that you pay for 2 things (a capital in case you die prematurely AND an account where your cash values grow) BUT you only receive one! Either you die and your beneficiary receives the death capital OR you cancel your policy and receive your cash values. It is not possible to receive both! And you pay generally more for this policy type.
If we look at an example: it’s been 20 years you pay for your policy of 100,000$ and you have on your statement 15,000$ of cash values. If you die, you spouse will receive the capital of 100,000$, because it is what you have bought in the first place, but the accumulated money in your cash values account stay in the insurance company profits.
This one is like a hybrid version of whole life, meaning that you are still covered until 100 years old with a fixed capital and you will pay for all your life. You might have a policy where what you pay will increase each year (because it is an Annually Renewable Term – ART) or you have a policy where the premium is leveled for the entire policy. The main difference here is you have 2 separate products: a life protection on one side and an investment product on the other. You have the option to pay more than your required premium each month and the surplus goes right into the investment account. There is a maximum that you can put aside so that your policy remains tax exempt. So the advantage here is that if you die, your beneficiary will receive the entire amount (capital + investment) and it will be tax free. That is the main point where the life insurance agent wants to sell on. Because it is tax free. But in that kind of insurance, you pay for a combined product that is costly.
The people that should by those kind if life insurance are mainly 35 to 55 years old, making at least 150,000$ in income, that are debt free and that are looking for tax advantage investments. Basically, they have the money to take advantage of the whole program and not just paying for the administrative costs. The percentage of people in the general population that fits into those criterias is really low.
Here comes the most simple, easiest and cheapest form of insurance. Not only does it make sure that in case you die you are well protected to the amount you would really need but also at a cost that leaves you with money you can invest for retirement.
Term life is based upon a fact that your financial responsibilities will decrease over time. When you are a young family with a big mortgage, is it normal to have a big coverage in case you die? As the time goes by, you mortgage goes down, your kids grow up and become less and less financially dependant of you. So your responsibilities decrease slowly each year to reach an all time low when you retire from your job.
That’s why, you can choose from 5, 10, 15, 20, 30 and 35 year terms to match your responsibilities. Read Term Life Insurance to know how to build your insurance program.
Why is it that cheap? Mainly because the risk taken by the insurance company is only on the next 10 or 20 years. So the chance of you dying in the next 20 next are dramatically lower than until you reach 100 years old. So the difference between what you would have paid on a whole life or universal life insurance and a term premium should be invested in tax-deferred products to make sure that when you get to retire, you have enough money put aside.
How to use the different types of life insurance
The first point should always be the same: you should use term life insurance to cover your needs in case you die prematurely… always. Make sure you read how to build your term life insurance program to make sure that you are well covered over the years.
After your needs are well covered, the second step is to set aside an investment program. Making sure that you build up assets for your retirement. You can’t buy anything at retirement with life insurance, so you better put money aside.
For those that fit into the “35 to 55 years old, making at least 150,000$ in income, that are debt free and that are looking for tax advantage investments” category, after being well protected with term, you could use universal life to invest money tax-free.
And for whole life, you can just forget it.