Becoming Familiar With Whole Life and Term Life Insurance
There are two basic types of life insurance, Whole life and Term life. Whole life insurance is a type of life insurance which has a guaranteed level death benefit until death, or the age of 100, which ever comes first. It also builds guaranteed cash value which will equal the face amount of the policy at age 100. So if you have coverage of $100,000 and you are still alive at age 100, the insurance company will void your life insurance policy and pay you $100,000. The premiums with Whole life will remain the same throughout the life of the policy and there are several ways you can pay your premiums. The most common way is called is a continuous premium. There is a limited pay or more commonly called "paid up life"; this could be for a specific period. There is "Life Paid at 60", meaning you stop making premium payments when you reach 60 years of age. You can choose a shorter period than 60 years of age, however the premiums will be higher.
A specialized policy is the "Single Premium Whole Life"; a policy where the entire premium is paid up front. One of the features of a Whole life policy is that it builds cash value. You can borrow from it but the question is, why do I have to borrow it, aren't the savings supposed to be my money? The answer is no, because these premiums belong to the insurance company; if you want to take money out of your life insurance, you have to borrow it. They will charge you a loan interest of anywhere between 5-8%, but still this could be a better rate than the bank would charge. The premiums paid in during the first several years of the policy go to pay for the creation cost, sales commissions and so on; there is no cash value accumulated during this time. For this reason, you will not be able to borrow from the cash value during that period of time. After the start-up period, you are guaranteed an interest rate of between 1-3%. The borrowed cash value reduces your death benefit by the amount you borrowed, but the premiums remain the same. The interest you paid doesn't go into your cash value; this is the company's profit. The agent will emphasize the cash value, however when you pass away, the insurance company keeps the cash value and will only pay the death benefit to your heirs. If you decide to cancel your whole life policy, you will get a partial amount of the cash value; also the insurance company will charge you a surrender charge on your cash value. It is important that you pay back any borrowed money from your cash value, otherwise you will have to pay income tax on the loan amount. In summary, these are the pros and cons of Whole Life insurance:
You are guaranteed coverage until you die or reach the age of 100, whichever comes first.
It builds cash value.
Because it builds cash value, this type of life insurance is very expensive.
Cash value grows at a low rate of return.
If you want to use the cash value, you have to borrow it and pay the loan interest of from 5-8%.
If you die, the insurance company keeps your cash value.
Term insurance provides death protection for a specified period, usually for twenty years. The only funding is if the insured dies during the specified term, in which case the company pays the face amount of the policy to the beneficiary. If the insured doesn't die during the term, the policy expires and there is no investment to recoup, since there is no cash value attached to Term life. However, you have the greatest possible protection for the lowest possible cost with Term life. A key point to remember about Term insurance is that if offers protection only for a specified period of time. Many insurance companies offer a renewable term, which grants the insured the right to renew the policy to a stated date or age. Because you are growing older and fall into a higher risk category, the cost to renew the policy goes up each year. The increase in premiums can be a problem, however with the mortality rates constantly changing due to advances in medical technology, the rates sometimes decrease, slightly increase, or stay same. If you buy a ten or twenty year term policy, generally the premiums are fixed for five or so years, and then they start to increase at various increments. One option available, which is a partial solution to the constant increasing of premiums, is known as level premium term. The payment is leveled out over the life of the policy to create the level term payment. Its cost is calculated by averaging the price for the early years and the price for the later years, therefore at the beginning you are making an overpayment and in the later years you are making an underpayment. This is a safe bet, however if you are in good health, you would be financially better off renewing at the end of each term.