Life insurance

Life insurance policies are contracts which are designed to protect the income or assets of the insured person in the event of his or her death.  There are many different types of policies including term insurance, whole life insurance, and universal life insurance.  We will briefly review each of these types of policies here.

Term Insurance – rental of coverage

With term insurance, the coverage is paid for a number of years, after which point the policy either terminates or becomes prohibitively expensive.  Term insurance is usually used to protect the income of a wage earner supporting children or debt such as a mortgage, and is typically the least expensive type of life insurance coverage.  The most significant advantage of term insurance is its low cost and its most significant disadvantage is its temporary nature and the fact that it usually will cover a person only in their younger years, when a claim is less likely to be filed.  Having term insurance is sometimes referred to as “renting” coverage as the policy holder does not have any equity in the policy and only pays for the coverage for the amount of time for which it is in force.

Whole Life Insurance – purchase of coverage

Whole life insurance is frequently referred to as “permanent” insurance, in that the coverage will remain in force for the duration of the insured’s life, as long as the premiums are paid.  This type of coverage is usually used in estate planning, and is typically the most expensive type of insurance.  Many types of whole life policies are “participating”, in that the policy holder is entitled to receive periodic dividends from the insurance carrier.  Whole life policies have a cash value which can be accessed by the policy owner by means of withdrawals, surrender, or loans.  Cash value growth inside life insurance policies is tax deferred and is subject to first in first out (“FIFO”) treatment as long as certain requirements are met.  What this means is that the tax free basis is withdrawn prior to the gains in the policy, so the policy owner will only be taxed when the amount of the withdrawals exceed the basis in the policy.  The “guarantees” provided by whole life policies are backed by the general account of the insurance carrier.  This is in contrast to the separate accounts of universal life insurance policies (discussed below), which are titled in the name of the policy holder.  Having whole life coverage is frequently referred to as purchasing coverage due to the fact that the policy holder builds equity in the policy.

Universal Life Insurance – flexible coverage

Universal life insurance can be permanent or temporary depending on how the policy is managed by the policy holder.  Premium payments are flexible, and the policy will last as long as the policy remains funded.  The policy is funded by means of the policy holder making premium payments as well as earnings inside the policy.  Similar to whole life insurance, universal life insurance has cash value which can be accessed by the policy owner by means of surrender, withdrawals or loans.  The sub accounts of a universal life policy are typically titled in the name of the policy holder and are thus not invested in the general account of the insurance carrier.  Universal life insurance can be used for a variety of purposes including estate planning, income protection and debt protection, and its cost depends on how the policy holder chooses to manage the policy.  There are several types of universal life insurance coverage including fixed and variable.  With a variable universal life insurance policy the funds inside the policy are invested in stocks, bonds, and other investments, and with a fixed universal life insurance policy the funds inside the policy are invested in fixed interest bearing accounts.