Gain insight into life insurance policies.
Determining which type of life insurance policy best suits you and your family can often be confusing. So the Independent Insurance Agents of America compiled this FAQ guide to provide you with the information you need to make the best decision. This guide does not represent the provisions of any particular policy, but it will serve as a starting point for your complete package of protection.
Which type of cash value life insurance policy, universal life (UL) or participating whole life (WL), is a “better buy” financially?
There is no simple answer to this question. The best performing product (from a financial perspective), whether UL, WL, or some other type of cash value life insurance, will likely be the one offered by the insurer that enjoys the best future experience as it relates to interest earnings, actual expenses and mortality costs. Insurers earning the highest investment income and incurring the lowest expenses and the lowest mortality costs are in the best position to offer life insurance at the lowest cost. This is true whether the cash value life insurance product being offered is UL or WL. Thus, it will be necessary for prospective insureds and their advisers to carefully examine the financial aspects of each product under consideration, regardless of whether the product is UL or WL.
What is variable life (VL) insurance, and how is it different from universal life (UL) and participating whole life (WL)?
Variable life insurance is a type of fixed-premium whole life insurance policy where changes in the policy’s cash values and death benefits are directly related to the investment performance of an underlying pool of assets. Policyowners typically can choose among several investment options as to where the assets backing the policy’s cash values will be invested. The various investment options offered in the contract generally possess different risk/return relationships and frequently include a money market fund, a bond fund, and one or more common stock funds. Although the policy’s death benefit is directly related to the actual performance of the invested assets, the policy prescribes that the death benefit will not fall below a minimum amount (usually the initial face amount) even if the invested assets depreciate in value by a substantial amount. Because the policyowner assumes all of the investment risk, there is no similar “floor” below which cash values may fall. In recent years, variable universal life (VUL) insurance has become a more popular product than VL. VUL combines features of both UL and VL and, in essence, is the flexible premium version of VL.
What is the tax treatment of life insurance cash values, dividends, and death benefits?
The “interest build-up” portion of the annual increase in the policy’s cash value is not taxed currently to the policyowner. Dividends generally are considered to be a “return of premium” and are not taxable to the policyowner. Although in the typical case, life insurance death proceeds will not be subject to income taxation, these proceeds may be subject to federal estate taxation. If the insured has any elements of ownership in the policy at the time of his/her death, the proceeds are includible in the insured’s gross estate for federal estate tax purposes. State inheritance taxes and federal gift taxes may also apply to life insurance policies/proceeds under specific circumstances. You should contact your tax adviser regarding questions concerning the possible income, estate and gift tax consequences surrounding any life insurance that you currently own or are contemplating purchasing.
What is participating whole life insurance?
Participating (par) whole life insurance has been marketed for many years in the U.S. The participating feature allows for the payment of dividends to policy owners when actual experience justifies such payment. Substantial amounts of participating whole life insurance is still sold today, principally by the large mutuals.
Should non-wage earning spouses be covered?
Non-income earning family members need very little to no insurance. Life insurance for a non-wage earning spouse may be recommended to cover the expense of providing domestic services.
Should I choose term insurance or cash value life insurance?
As a minimum, you should purchase term insurance. Your financial situation may exclude the possibility of purchasing adequate coverage any other way. If you can afford adequate coverage and cash value life insurance, then this becomes a complex financial decision in which you should consider your income tax bracket, the length of time you expect to be covered (if short term, term insurance is preferred), and the expected rate of return and risks associated with alternative investments.
I’ve heard of people purchasing life insurance on children. Do I need it?
Generally no. In dual income families it is important to protect the wages of both spouses, however.
I have heard a lot about universal life insurance. How is this type of life insurance different from traditional whole life insurance?
Both traditional whole life (WL) and universal life (UL) products are examples of cash-value life insurance. However, there are several important differences between these two products. While WL policies contemplate the payment of fixed, level premiums and provide for level death benefits, UL policies offer adjustable death benefits and flexible premiums that can be varied according to changing circumstances. This is a rather simplistic comparison, however, since policyowner dividends under participating WL insurance contracts can be used to offset a portion of the premium payment otherwise required; in addition, dividends can be used to increase the policy’s death benefit. Because of these and other possible uses of policyowner dividends, an argument can be made that participating WL insurance possesses some (but not all) of the same flexibility/adjustability that is possessed by UL policies. Another important difference between WL and UL relates to product transparency. In UL policies, it is easy for policyowners to look at the internal operations of the policy and to examine the relationships among various policy elements (premiums, cash values, interest credits, mortality charges, and expenses) and how they interact with each other.
How much life insurance coverage should I own?
The common recommendation is that life insurance equal to 6 to 8 times annual earnings. Also consider factors such as total family income and earnings, marital status, the number of individuals who are financially dependent on the insured, other life insurance plans, Social Security, upcoming expenses such as mortgage, college, and estate planning. With so many factors to consider you may need help from an experienced professional. Your insurance agent can assist you with determining a more precise number.
How is this different from mortgage protection term insurance?
The face amount under mortgage protection term insurance decreases over time, consistent with the projected annual decreases in the outstanding balance of a mortgage loan. Mortgage protection policies are generally available to cover a range of mortgage repayment periods, e.g., 15, 20, 25 or 30 years. Although the face amount decreases over time, the premium is usually level in amount. Further, the premium payment period often is shorter than the maximum period of insurance coverage–for example, a 20-year mortgage protection policy might require that level premiums be paid over the first 17 years.
For some big-ticket items such as cars and major appliances, salespeople have recommended credit life. Is credit life insurance a good buy?
Credit life insurance is frequently more expensive than traditional term life insurance so it doesn’t normally offer you any advantages. Usually, you are much better off reviewing your existing life insurance coverage and increase your coverage as needed.