People tend to avoid the conversation when you talk about stuff like living trust wills and life insurance. Why? because it forces you to address your own mortality. People don’t like to talk about death and what that might mean but it's an inevitable part of life. Let me say it again death, just like taxes, are inevitable. Although most people may not be keen to dwell on it you should be taking steps so your death isn’t a liability to your family, especially if you have loved ones who depend on your income.
Most insurance companies say a reasonable amount for life insurance is six to ten times the amount of annual salary. One of the biggest factors for life insurance is to replace income. If you are the sole provider for your dependents and bring in $40,000 a year, for example, you will need a policy payout that is large enough to replace your income, plus a little extra to guard against inflation.
Life insurance falls into two different categories: whole and term.
Whole life policies are a type of permanent life insurance, meaning you’re covered for life as long as your premiums are paid. Some whole life policies offer an investment component that allows you to build cash value, taking the premiums you pay and investing them into the market.
There are three major types of whole life or permanent life insurance—traditional whole life, universal life, and variable universal life,
Whole or ordinary life
This is the most common type of permanent insurance policy. It offers a death benefit along with a savings account. If you pick this type of life insurance policy, you are agreeing to pay a certain amount in premiums on a regular basis for a specific death benefit. The savings element would grow based on dividends the company pays to you. The savings vehicle (called a cash value account) generally earns a money market rate of interest. What the company decides to pay you can vary and usually adjusted at any point in time.
Universal or adjustable life
This type of policy offers you more flexibility than whole life insurance. You may be able to increase the death benefit, if you pass a medical examination. After money has accumulated in your account, you will also have the option of altering your premium payments providing there is enough money in your account to cover the costs. This can be a useful feature if your economic situation has suddenly changed. However, you would need to keep in mind that if you stop or reduce your premiums and the saving accumulation gets used up, the policy might lapse and your life insurance coverage will end.
Variable life
This policy combines death protection with a savings account that you can invest in stocks, bonds and money market mutual funds. The value of your policy may grow more quickly, but you also have more risk. If your investments do not perform well, your cash value and death benefit may decrease. Some policies guarantee that your death benefit will not fall below a minimum level but the catch is the upside is usually capped as well. Last year S&P 500 earned 30% return. If the money was invested in an S&P 500 ETF you would receive 30% but If your life insurance policy that mirrors the S&P is capped at 15%? well you only earn 15%. The insurance companies say the additional return will be used to fund the account in underperforming years but only to a tune of say 4-7%.
Term life insurance, on the other hand, covers you for a set term. For instance, you may purchase a 20- or 30-year policy, depending on your age and how long you need coverage. Some policies allow you to renew your coverage after a certain expiration date, while others require a medical exam to do so. Between term life and whole life insurance, term life tends to offer cheaper premiums. The older you get the more expensive term life is. There are two basic types of term life insurance policies: level term and decreasing term. Level term means that the death benefit stays the same throughout the duration of the policy. Decreasing term means that the death benefit drops, usually in one-year increments, over the course of the policy’s term.
Last thing to consider when purchasing life insurance is the fees. Regulation allows for up to 8% to be charged for a management fee. With insurance policies any profits you may gain with the cash value can be eroded by sales commissions, sales charges, administration fees, mortality charges and surrender charges. To put things in perspective a typical financial advisor will charge a client around 1% of their assets under management. Bottom line is you need to do your due diligence when buying a policy because while the tax free growth of your policy is a great selling point if the fees which once again can be as high as 8% are being accrued it'll cancel out the long term growth potential.