Financial advisors often propose term life insurance, but most individuals choose for something else.
There are two types of life insurance available: term and permanent. The latter group includes whole life and universal life.
Term life insurance is frequently the most cost-effective option for most people, according to financial experts.
The American Council of Life Insurers predicts that 60% of policies sold in 2021 will be permanent, while 40% will be term.
There are two forms of life insurance, and research suggests that many households do not get the less expensive one. According to the American Council of Life Insurers’ most current figures, Americans purchased 4.1 million term insurance plans in 2021, accounting for 40% of all individual policies purchased that year. Permanent life insurance accounted for around 6.3 million policies, or almost 60% of all plans.
However, this appears to contradict standard financial advice.
“Most people just need term insurance,” Carolyn McClanahan, a registered financial planner and member of CNBC’s Advisor Council based in Jacksonville, Florida, said.
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What is the distinction between term life insurance and permanent life insurance?
Life insurance is a sort of financial protection that pays out money to dependents if the policyholder dies, such as children or a spouse.
Term insurance only provides a death benefit for a specified number of years, such as 10, 20, or 30. The coverage terminates after that period unless renewed.
Permanent insurance policies, such as whole life and universal life, on the other hand, give coverage until the policyholder dies. They are also known as cash-value insurance since they include interest-bearing accounts.
According to advisors, permanent insurance is frequently more expensive. Policy premiums are paid over a longer period of time, with the earnings used to cover insurance costs and accumulate cash value.
“Term insurance will probably be the most cost-effective way to address survivor income needs, especially for minor children,” Marguerita Cheng, a CFP in Gaithersburg, Maryland, and member of CNBC’s Advisor Council, said.
Individual premiums may differ greatly. Insurers calculate them based on the policy’s face value as well as the policyholder’s age, gender, health, family medical history, profession, lifestyle, and other factors.
Why you may require permanent life insurance
According to McClanahan, founder of Life Planning Partners, there are three major reasons why having permanent coverage, despite the higher rates, may make more sense. This would attempt to ensure that a death benefit is paid regardless of when it occurs.
According to McClanahan, some beneficiaries, such as children with special needs, may require financial help for a lengthy period of time, and a policyholder’s lifetime assets may not be adequate to cover their needs.
Some policyholders may also want to leave a financial legacy to family members or nonprofit organizations. Furthermore, some people may have a minor health problem that might worsen in the future. According to McClanahan, the policyholder may be uninsurable at that point, in which case it would be better to obtain a permanent insurance now to assure coverage later.
Some clients buy permanent life insurance for the cash value, thinking they would be able to borrow against it or use it as a retirement savings account. According to McClanahan, it is a “horrible reason” to buy a permanent coverage, and the fundamental reason for getting a policy is always for an insurance need.
If the cash value of insurance is accessed, for example, there may be taxes and penalties. Withdrawing or borrowing too much money from a permanent policy may cause it to lapse, leaving the owner without insurance.
According to McClanahan, policyholders should instead use the cash value as an emergency fund at the end of their lives, similar to house equity.
How to Determine the Cost and Term of Life Insurance
According to Cheng, CEO of Blue Ocean Global Wealth, when deciding how much life insurance to buy, potential buyers should consider the “three Ls”: liability, loved ones, and legacy.
For example, if you died, how much money would you want to leave for obligations like a mortgage, student bills, or auto loans? How much money would a policyholder’s loved ones, such as a spouse and children, need if the policyholder’s income was suddenly lost? How much money would you wish to leave as a legacy for causes that are important to you?
According to Cheng, thinking about these questions will assist frame the term of a policy.
Cheng gave an example from her personal experience. When all three of her children were under the age of 18, she purchased a 20-year term insurance policy with a death payout of $750,000. Her husband likewise works and has a solid income. If Cheng had died early, each of his children would have received $250,000 to assist pay for their education. She also bought $250,000 in permanent insurance for Cheng’s wife to help them pay off their mortgage.
Combining term and permanent insurance policies, according to experts, can help make an insurance purchase more cost-effective than getting simply permanent insurance.
Advisors advise anyone buying term insurance to have “convertible” term insurance. When a policyholder’s term insurance expires, they can convert it to permanent coverage without having to go through another round of medical underwriting. If the individual is currently in poor health, coverage may be denied.