If you have a mortgage or have children, then there is a good chance that life insurance is a necessary piece of your overall financial plan. If you were to die prematurely, would your family still be able to afford your mortgage on a single income stream? Would your spouse have to change jobs or return to work to pay the bills and attempt to maintain the family’s standard of living? With potentially only one parent, would someone need to be brought in to help raise your children? How would that be paid for? Will your children’s college educations still be paid for? Life insurance can help ensure your family’s goals and lifestyle does not have to change even if you are not there to provide.
Depending on your goals and what you are trying to pay for with life insurance, there are different types of policies that may be a good fit. Let’s look at some of the more common types of life insurance and their pros and cons:
Term Life Insurance- Often the goals you are trying to protect with life insurance are temporary. For example, if covering the balance of a mortgage, protection is only needed for the duration of the loan which is typically 15, 20, or 30 years. If covering a child’s college education, coverage is only needed until the child has completed their education. Term insurance has no cash value or savings component attached to it, meaning that if you don’t use it, you won’t get any of your premiums back. However, because of this and the shorter coverage period, these policies tend to be significantly less expensive than whole life or variable products. Quite simply, you pay your premium, and if you die during that policy year, the death benefit is paid to your beneficiary.
Whole Life Insurance- Just as it sounds, whole life insurance is intended to cover you for your entire life. This type of coverage is commonly used to give an inheritance, make a charitable donation, or pay estate taxes. Unlike term insurance, whole life insurance has an internal cash value account. When each premium payment is made, a portion of that premium goes into a savings account within the policy. This cash value account is guaranteed a modest return, so the money continues to grow. The money in the cash value account can be withdrawn, you can take a loan against it, or you can eventually use it to pay your premiums. Any portion of the money you contributed to the cash value account comes out tax free, but any investment growth must be included in your income for tax purposes. Due to the dual nature of the premium payments, where a portion pays for the life insurance and the remainder goes into the cash value account, the cost of a whole life policy is often significantly higher than a term life insurance policy.
Universal Life Insurance- This type of coverage works very similarly to whole life insurance except it provides some added flexibility. Universal life allows you to adjust your premiums or death benefit if needed. If the cash value of your account can cover the costs, you may have the ability to lower or stop paying your premiums on a universal life policy for a certain amount of time. However, there can be negative consequences too. Your coverage may end if you use up the account’s cash value to pay for premiums. Indexed universal life policies also allow you to invest the money in the cash value account, however, there are often caps on how much you can earn in those investments. The death benefit can also be adjusted up or down to fit your evolving needs.
Variable Life Insurance- This type of coverage has a much greater investment focus to it. In a variable policy, you can choose much more specific investments like an S&P 500 fund, an emerging markets fund, or domestic bond fund. These options typically allow you to tailor the investment strategy, so it aligns with your investment strategy elsewhere, like your retirement account. The investment growth is also tax-deferred. The downside to variable policies is often the cost. The individual investments carry their own expense ratios, and the policy itself tends to have some higher fees than other types of life insurance. This type of coverage is most commonly used once all other tax-deferred retirement vehicles have been maxed out. However, the costs compared to investing in taxable accounts should be examined.
Depending on your goals and what you would like to cover, there are different options available to you. Careful consideration should be given to the type of policy suitable for each goal you want insured. We highly encourage you to work with an insurance professional to navigate which type of policy is right for you.
Jeff Witz, CFP® welcomes readers’ questions. He can be reached at 800-883-8555 or at email@example.com.
The material has been prepared or distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Investing involves risk, including risk of loss. Before investing, you should consider the investment objectives, risks, charges, and expenses associated investment products. Investment decisions should be based on an individual’s own goals, time horizon and tolerance for risk. Past performance is no guarantee of future results. Diversification and asset allocation do not ensure a profit or guarantee against loss. Consult your financial professional before making any investments.
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