Life insurance comes under two broad categories—whole and term life insurance. Term life insurance is the simplest, most straight-forward form of life insurance. You simply pay regular premiums in order for your beneficiary to receive a pre-determined death benefit. Since there is no investment component, term life insurance is the cheapest life insurance you can buy. You can purchase term or temporary life insurance for specific term periods such as 10, 20, or 30 years.Permanent life insurance not only guarantees a death benefit, but it’s a popular policy because a portion of the premiums you pay goes toward building cash value. The dividends that are earned can later be used to pay off future premiums. A few variations of permanent life insurance are mentioned here:
- Whole life insurance consists of two elements—a guaranteed and non-guaranteed cash value. The guaranteed cash value grows at a pre-determined schedule and reaches maturity at the age of 100. The non-guaranteed cash value consists of “dividends” or “excess interest” that can add cash value to your policy over a period of time.
- Universal life insurance allows you to raise or lower the face value of your policy and vary the amount or timing of the premiums that are utilized in the cash value part of the policy. You can take advantage of high interest rates, but you need to note that universal life insurance is also more vulnerable to market fluctuations. If the market is down for a prolonged period of time, the returns could be disappointing and lead to a raising or extending of your premium payments.
- Variable life insurance is a hybrid of whole life and universal. It allows policyholders to choose the mutual funds they would like to invest in, where you can manage your own investments and use the earnings to pay off premiums. While variable life insurance offers the freedom to choose your own investment schemes, there is usually a very limited option and the returns that you generate are small and lack the full potential of other more profitable investment vehicles such as stocks, bonds, mutual funds, etc.
Permanent life insurance has advantages since it is a life time insurance plan. Many people use it as a tool in planning their estate taxes. Those who have a child with “special needs” may want to make sure they leave behind a significant amount of money that would take care of the needs of a special child. Seniors may purchase life insurance to augment their retirement fund. However, if you’re thinking of purchasing whole life insurance solely because of it offers a savings component, you should take note of some of the drawbacks listed below.
Unrealistic expectations of returns
Permanent life policies generally give individuals an unrealistic projection of earnings. No agent can guarantee how much cash value your permanent life insurance would have in the future. For example, in the 1980s, most experts believed that universal policies would continue to earn double-digit interest rates. Today, those who purchased these policies in the 19080s are still paying off their premiums because interest rates have declined, causing premium costs to rise.
Permanent life insurance carries several hidden expenses such as mortality charges, insurance related administrative fees, which are deducted from the cash value every month. These high fees and expenses eat into the investment component, not allowing the policy to reach its full potential. It’s often better to max out other tax-deferred investment options before investing in a whole life policy.
Loans against the Policy and Surrender Value
A lot of people purchase permanent life insurance policies thinking they can borrow from it when they need cash, or use the cash value as an annuity. You need to remember that when you borrow from the cash value of your permanent life policy, you need to pay the money back with interest. If this is not possible, the loan amount with interest will be deducted from your death benefits.
If you decide you no longer need insurance, the surrender value of a permanent life insurance policy is pretty paltry compared to the amount you have put in and the number of years the policy has been in place.
The commission that a life insurance agent earns off a permanent life policy can amount to 50 to 70 percent of your first year’s premium payment. If an agent is trying to tough sell a whole life policy to you, you know why! You need to carefully consider whether permanent life insurance really suits your purpose.
Think carefully before you choose permanent life insurance. The best life insurance is the one that suits your purposes and if your life insurance needs are temporary, then a cheap term life insurance policy may be your best option. Term life is cheaper and you can find competitive term life insurance rates on aggregator life insurance websites.
This article was a guest post by Denise Mansini of Accuquote