What Type of Life Insurance Should I Get?
If your sole purpose in buying life insurance is to replace your lost income during your most vulnerable years, we generally recommend term insurance,
Why Term Insurance?
This is because the insurance amount needed to cover lost income tends to be fairly large — as in one to many millions of dollars. Term insurance allows you to buy the most insurance for the lowest premium. With permanent insurance like whole life or universal life, premiums would be significantly higher for the same amount of coverage.
So how does term insurance work? It's pretty straightforward. You pay for the cost of insurance for a desired death benefit. It's "pure" insurance. It doesn't accumulate cash value, pay dividends or any have "savings" component. If you die while the policy is in force, it pays proceeds to your beneficiaries. If you don't die (that's good news) and the policy expires, then you and the insurance company shake hands and walk away. You owe them nothing, and they owe you nothing.
As the name implies, term insurance doesn't provide permanent coverage. Rather, it's available for a certain term. At its purest form, its premium increases every year because, well, as we grow one year older, we are one year closer to dying. This type of term product is called annual renewable term insurance (or ART). And then after a certain age, say age 70, it is no longer available even if you want to buy a policy.
In real life, ART is not sold very often. People generally prefer the predictability of paying the same premium every month/year. The typical term products sold in the marketplace provide level premium for a period of years. When you hear someone say, "10-year term" or "20-year term," it simply means that the premium stays the same—or is "level"—for 10 years or 20 years instead of increasing each year. You pay a little more upfront for lower premiums in later years.
Why Permanent Insurance?
That being said, there are situations where a permanent insurance might be more appropriate.
Life insurance has unique tax benefits unlike any other financial instrument available. Among them are:
These truly are unique tax benefits. And they are not available through any other financial instruments. Thus, many families and businesses leverage these unique tax benefits of life insurance in various ways.
Product selection and policy design, as well as underwriting considerations, are critically important in these more sophisticated uses of life insurance. For example, executive benefits that are financed with life insurance typically (though not always) use institutional products known as COLI (corporate owned life insurance) with high early cash values.
Moreover, for estate planning, as applicable, a second-to-die policy is often used to maximize the death benefit with the lowest possible premiums. When premiums are high relative to the available annual gift amount, additional strategies are often considered to minimize annual gifts. Needless to say, underwriting must be handled gingerly with multiple carriers to receive the best possible offer.
* You can get around the death benefit being included in your gross estate by having someone else (for example, an irrevocable life insurance trust or "ILIT") own your policy.
Why Term Insurance?
This is because the insurance amount needed to cover lost income tends to be fairly large — as in one to many millions of dollars. Term insurance allows you to buy the most insurance for the lowest premium. With permanent insurance like whole life or universal life, premiums would be significantly higher for the same amount of coverage.
So how does term insurance work? It's pretty straightforward. You pay for the cost of insurance for a desired death benefit. It's "pure" insurance. It doesn't accumulate cash value, pay dividends or any have "savings" component. If you die while the policy is in force, it pays proceeds to your beneficiaries. If you don't die (that's good news) and the policy expires, then you and the insurance company shake hands and walk away. You owe them nothing, and they owe you nothing.
As the name implies, term insurance doesn't provide permanent coverage. Rather, it's available for a certain term. At its purest form, its premium increases every year because, well, as we grow one year older, we are one year closer to dying. This type of term product is called annual renewable term insurance (or ART). And then after a certain age, say age 70, it is no longer available even if you want to buy a policy.
In real life, ART is not sold very often. People generally prefer the predictability of paying the same premium every month/year. The typical term products sold in the marketplace provide level premium for a period of years. When you hear someone say, "10-year term" or "20-year term," it simply means that the premium stays the same—or is "level"—for 10 years or 20 years instead of increasing each year. You pay a little more upfront for lower premiums in later years.
Why Permanent Insurance?
That being said, there are situations where a permanent insurance might be more appropriate.
Life insurance has unique tax benefits unlike any other financial instrument available. Among them are:
- Death benefit is generally income tax free (but it's included in the gross estate so it's not estate tax free)*
- Dividends and interest credited toward cash value accumulation are generally not taxable
- Loans taken against the cash value are generally not taxable
These truly are unique tax benefits. And they are not available through any other financial instruments. Thus, many families and businesses leverage these unique tax benefits of life insurance in various ways.
- For high-income individuals with life insurance needs, build cash value without current tax liability or contribution limits
- Finance estate tax requirements to provide liquidity to pay estate tax*
- Finance nonqualified executive benefit obligations
- Finance business succession objectives
Product selection and policy design, as well as underwriting considerations, are critically important in these more sophisticated uses of life insurance. For example, executive benefits that are financed with life insurance typically (though not always) use institutional products known as COLI (corporate owned life insurance) with high early cash values.
Moreover, for estate planning, as applicable, a second-to-die policy is often used to maximize the death benefit with the lowest possible premiums. When premiums are high relative to the available annual gift amount, additional strategies are often considered to minimize annual gifts. Needless to say, underwriting must be handled gingerly with multiple carriers to receive the best possible offer.
* You can get around the death benefit being included in your gross estate by having someone else (for example, an irrevocable life insurance trust or "ILIT") own your policy.
