I get many questions regarding life insurance, and while I am happy to advise on the many estate and gift tax consequences related to life insurance, I leave the recommendations of why, how much and why to the life insurance experts. The information below is provided courtesy of Mr. David Kulawiak.
David is an insurance broker and owner of Our Community Insurance Consultants. He provides all types of insurance to individuals and small businesses. David is a specialist in Disability Income Insurance, Long Term Care Insurance, and Property and Casualty Insurance for the Nonprofit sector. He is also an owner of www.GayInsurance.com serving the LGBTQ Community in the Chicagoland area.
Last month, I posted the first part of David’s entry, which covered the “Why?” and “How much?” questions of life insurance. This second part covers the many types of life insurance policies and how they are sold.
What are the principal types of life insurance?
There are two major types of life insurance—term and whole life. Whole life is sometimes called permanent life insurance, and it encompasses several subcategories, including traditional whole life, universal life, variable life and variable universal life. In 2003, about 6.4 million individual life insurance policies bought were term and about 7.1 million were whole life.
Life insurance products for groups are different from life insurance sold to individuals. The information below focuses on life insurance sold to individuals.
Term
Term Insurance is the simplest form of life insurance. It pays only if death occurs during the term of the policy, which is usually from one to 30 years. Most term policies have no other benefit provisions.
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.
In 2003, virtually all (97 percent) of the term life insurance bought was level term.
Whole Life/Permanent
Whole life or permanent insurance pays a death benefit whenever you die—even if you live to 100! There are three major types of whole life or permanent life insurance—traditional whole life, universal life, and variable universal life, and there are variations within each type.
In the case of traditional whole life, both the death benefit and the premium are designed to stay the same (level) throughout the life of the policy. The cost per $1,000 of benefit increases as the insured person ages, and it obviously gets very high when the insured lives to 80 and beyond. The insurance company could charge a premium that increases each year, but that would make it very hard for most people to afford life insurance at advanced ages. So the company keeps the premium level by charging a premium that, in the early years, is higher than what’s needed to pay claims, investing that money, and then using it to supplement the level premium to help pay the cost of life insurance for older people.
By law, when these “overpayments” reach a certain amount, they must be available to the policyholder as a cash value if he or she decides not to continue with the original plan. The cash value is an alternative, not an additional, benefit under the policy.
In the 1970s and 1980s, life insurance companies introduced two variations on the traditional whole life product—universal life insurance and variable universal life insurance.
How is life insurance sold?
You can buy life insurance either as an “individual” or as part of a “group” plan.
Individual Policy
When you buy an individual policy, you choose the company, the plan, and the benefits and features that are right for you and your family. You might be able to buy the policy from the same agent or company representative who sells you property and liability insurance for your home, auto or business. And although you won’t qualify for any discounts by buying your life insurance and other insurance from the same representative, working with a single advisor for all your insurance needs can make your financial life simpler.
Individual policies are typically sold through insurance agents or brokers. If you buy a policy through an agent or broker, you will pay a commission, also called a “load,” that is built into the premium rate. The commission compensates the agent or broker for the time spent advising you on how much and what type of life insurance to buy, for facilitating the application process, and for any further service that’s needed in future years to keep the policy up-to-date (such as changing beneficiary designations, arranging policy loans or coordinating your financial plans with your lawyer and accountant).
There are two other ways to buy individual life insurance. In Connecticut, Massachusetts and New York, you can buy it from a savings bank. Or you can buy a policy directly from an insurance company or from a fee-only financial advisor—what’s known as a “no load” or “low load” policy. Although there is no sales commission on these policies, the company will still have charges built into the premium to cover its marketing expenses, application processing expenses and subsequent services. Finding an insurance company that will sell you a no-load policy isn’t easy; typing in “no load life insurance” on Internet search engines will in many cases lead you to an agent or broker.
Group Policy
You might have life insurance automatically from your employer; many large companies do this. Your employer also might offer you the chance to buy additional life insurance under a group policy. And you might be eligible to buy life insurance under a group policy from a union or trade association or other group you belong to (such as a college alumni association or an automobile club).
Compared to buying an individual life insurance policy, there are several advantages to buying life insurance under a group policy:
- Group purchase can sometimes offer you a lower rate for a given death benefit either because the employer or other group sponsor subsidizes the premium or because the rates are averages weighted by people younger than you.
- There are virtually no health qualifications for getting the group coverage.
- Premium payment is usually by payroll deduction (for employer-based group coverage) or linked with other payments (e.g., credit card bills), lowering the chance of missing a payment.
Most employer group plans are term insurance, but if you leave that employer your state may require that you be allowed to convert the policy to a form of whole life insurance with the same insurance company that provides the group life insurance. You would then pay premiums directly to the company and keep the insurance in force. This can be an advantage if you are older, or have experienced deteriorating health, as it gives you the opportunity to qualify for whole life insurance without having a medical exam.
Credit Life Insurance
Credit cards and lending institutions may offer life insurance to pay off your outstanding loans in the event of your death. This is generally made available in two ways:
- As part of the loan at no extra charge. In this case the cost of the life insurance is borne by the lender and is included in its interest rate or other finance charges. If you have this type of credit life insurance, you don’t need separate life insurance to pay off that loan if you die.
- As an option at an extra charge. In this case, you should usually reject the optional coverage, provided that you have some other life insurance (group or individual) that can be designated to pay off the loan if you die. If you’re under age 50 and you don’t have other insurance that could pay off this loan, consider buying individual life insurance for this purpose as the rates will probably be better. At 50 or over (or younger with health issues), if you have no other life insurance for this purpose, the optional credit life insurance is likely to be cheaper than individual life insurance.
What is a beneficiary?
A beneficiary is the person or entity you name in a life insurance policy to receive the death benefit. You can name:
- One person
- Two or more people
- The trustee of a trust you’ve set up
- A charity
- Your estate
If you don’t name a beneficiary, the death benefit will be paid to your estate.
Two “levels” of beneficiaries
Your life insurance policy should have both “primary” and “contingent” beneficiaries. The primary beneficiary gets the death benefits if he or she can be found after your death. Contingent beneficiaries get the death benefits if the primary beneficiary can’t be found. If no primary or contingent beneficiaries can be found, the death benefit will be paid to your estate.
As part of naming beneficiaries, you should identify them as clearly as possible and include their social security numbers. This will make it easier for the life insurance company to find them, and it will make it less likely that disputes will arise regarding the death benefits. For example, if you write “wife [or husband] of the insured” without using a specific name, an ex-spouse could claim the death benefit. On the other hand, if you have named specific children, any later-born or adopted children will not receive the death benefit—unless you change the beneficiary designation to include them.
Besides naming beneficiaries, you should specify how the benefits are to be handled if one or more beneficiaries can’t be found. For example, suppose you have two children and you name each one to receive half of the death benefit. If one of the children dies before you do, do you want the other child to get the entire death benefit, or the deceased child’s heirs to get his or her share?
If the death benefit goes to your estate, probate proceedings could delay distributing the money, and the cost of probate could diminish the amount available to your heirs.
Choosing beneficiaries, and keeping those choices up-to-date, is an important part of owning life insurance. The birth or adoption of a child, marriage or divorce can affect your initial choice. Review your beneficiary designation as new situations arise in order to make sure your choice is still appropriate.