Estate PlanninG

Which Type of Life Insurance Policy Is Right For Me?

When was the last time you thought hard about your life insurance policy?

Maybe you’re like most Americans - you start your full-time job, and the company’s HR manager asks if you want to enroll in the employer’s group life insurance policy. You thought “Why not?” and signed up, named a family member as your beneficiary, and then moved on.

Maybe you’ve never considered life insurance at all.

There are several types of life insurance. It will require careful consideration and possibly a discussion with you attorney to determine which policy is right for you.

What Is Life Insurance?

Let’s get down to the basics. Life insurance is a contact between two parties, usually an individual and an insurance company, in which the company agrees to pay a specified sum of money (death benefit) upon the death of the insured to the beneficiaries named in the policy. This would replace the economic loss that would otherwise be incurred by the beneficiaries because of the insured person’s death. The insured person who purchases the policy agrees to pay premiums to the company for a specified period of time, up to a specified amount, or both.

Life insurance can provide massive economic benefits as well as peace of mind for you and your loved ones in the event you pass away sooner than expected.

Types of Life Insurance

Term insurance. This type of life insurance will pay the death benefit only if the insured dies within a specific period of time (term) spelled out in the insurance contract. For example, if the policy is for a ten-year term but the insured dies in year eleven, no death benefit will be paid to the beneficiaries. While this might seem morbid, this type of insurance is meant to protect the insured’s beneficiaries in case premature death creates economic hardship within the specified term period. It’s also generally much more affordable than other types of policies.

Whole life insurance. Unlike term insurance, whole life insurance is a type of permanent life insurance. It provides permanent death benefit coverage for the life of the insured. The premiums are usually higher than term-life premiums because the insurance company maintains a reserve that helps keep the premiums level during the insured’s life. This reserve is an accumulated cash value within the policy that the policy owner can borrow against or cash out if they choose to terminate the contract before they die.

Universal life insurance. This type of life insurance is an interest-sensitive policy that can result in higher death benefits and cash value over the life of the policy, depending on a variety of investment, expense, and mortality factors that are built into the contract. Compared to whole life policies, universal life insurance policies are generally significantly more flexible with regard to making premium payments from year to year and withdrawing cash value. Therefore, depending on your circumstances, the type of cash flow you anticipate, and the risks that you are insuring against, a UL policy may be appropriate. As with most insurance policies, you will find limitless varieties from insurer to insurer.

Variable life insurance. Variable life insurance policies are very similar to traditional whole life policies except that in variable life insurance policies, neither the death benefit nor the surrender value of the policy is guaranteed. In addition, either the death benefit or the surrender value, or both, can increase or decrease depending on the performance of the policy’s underlying investments. However, each variable life insurance policy typically has a minimum death benefit so that, even with poor asset performance, the beneficiaries receive a payout at the insured’s death. These policies are unique because of the control that the policy owner has over the types of investments underlying the policy. The policy’s cash value can be invested in varying degrees in stocks, bonds, real estate, and money market portfolios. Policy premiums are typically fixed, but depending on the underlying assets’ performance, the cash value can fluctuate from day to day. As with other life insurance products, the death benefits are income tax-exempt. The earnings on the assets and the accumulated cash value in the policy are income tax-deferred until after the policy has been surrendered. In addition, the policyholder can also borrow up to a certain percentage of the policy’s cash value if they need cash for a period of time (although interest is charged while the loan is outstanding).

Variable universal life insurance. Variable universal life insurance is, as the name indicates, a hybrid of variable life and universal life insurance, with many of the most desirable features of both types of insurance built into the contracts:

  • Flexible premiums

  • Adjustable death benefits

  • Control over the types of investments within the policy

  • The ability to borrow against the cash value

  • Partial withdrawal rights

Both variable universal life insurance and variable life insurance policies are subject to Securities and Exchange Commission (SEC) regulation because of the flexibility of their investment options.

Survivorship life insurance. Sometimes called “second-to-die” life insurance, survivorship policies can be used when the need for an infusion of cash (the death benefit) is necessary only at the death of the second of two individuals (such as a married couple). These policies can be term, whole, universal, or variable, depending on the policyholders’ need. Survivorship policies are particularly useful when a married couple owns significant real property that they want to keep in the family after the second spouse dies, and the family would rather pay estate taxes from the life insurance proceeds than raise the cash to pay the taxes by selling the property.

First-to-die life insurance. First-to-die policies allow the death benefit to be paid upon the death of the first of two insured individuals. Insuring two individuals instead of one costs less than the total premiums for separate life insurance policies on the same two individuals. For example, these policies can provide a surviving business partner with the cash necessary to buy the deceased partner’s share of the business from their spouse or family.

Single premium whole life insurance. Single premium whole life insurance allows an individual to purchase, with a single cash payment, a specific amount of insurance to cover the remainder of their life. As with typical whole life, the insured can borrow against the policy’s cash value or surrender the policy. There may be income tax consequences for surrendering the policy, but as with most other life insurance policies, there can be significant income tax protection if the policy matures and pays out at the insured’s death. Also, in some states, the cash value of life insurance can enjoy significant asset protection against future creditors’ claims, thus making investing in life insurance more attractive than other types of investments.

Which Type of Insurance Is Best for Me?

As you can see, there are many different types of life insurance policies with numerous variations. Choosing which policy is right for you and your loved ones can feel overwhelming.

If you are a young couple just starting out and you do not have much spare income, it may be best to shop for some term insurance that will provide a cash payment that allows your surviving spouse to pay off the home and have sufficient income until they can provide for themselves on their own.

If you are a middle-aged working professional with a family, you may want to consider purchasing a much larger term life policy or even a whole life policy that has a guaranteed death benefit as long as you keep paying the premiums. This option can be important if there is a chance that you could develop a chronic illness, such as diabetes or cancer, that would disqualify you from obtaining a new term policy when your old term policy terminates.

If you have a large estate with significant assets that would be difficult to sell, such as a successful business or real estate, a second-to-die or first-to-die policy might be a better option for ensuring that there is sufficient cash upon the death of one or both of you and your spouse, or business partners, to pay taxes or buy out a deceased partner’s business interests.

The bottom line is that life insurance policies come with a huge variety of options because families and individuals have an endless variety of circumstances. Ask your insurance professional, financial advisor, and estate planning attorney to help you identify the risks that you may be facing that could be reduced by using a carefully crafted insurance policy, coordinated with your estate planning, to meet your unique needs. Insurance can be complex, but you do not have to go it alone. We’re here to help. Call Santaella Legal Group, serving San Ramon, Danville, Dublin, Pleasanton & the Tri-Valley area at (925) 831-4840.