| These are the two main
forms of life insurance you should understand. (It's also good to learn
about universal and variable, which are variations of whole life insurance.)
With term insurance, you're covered only
during the life of the policy, while you're paying the premiums. If you
carry a term life insurance policy for 50 years, regularly pay the premiums,
and then quit paying and die a year later, you're out of luck. (Well, you'd
be out of luck regardless -- but, in this case, your beneficiaries are out
of luck, too.)
There are several forms of term
insurance:
- With level term, you pay a fixed
premium for up to 20 years. This can be a good deal, as it protects you
against the effects of inflation and unexpected changes in your health
that would warrant higher premiums.
- Annual renewable term gives you the
option of renewing your policy regularly, but at increasing premium rates.
- Decreasing term policies feature a
steadily decreasing death benefit. This might seem undesirable, but it can
be sensible for many people. You may need a bigger benefit when you're a
young breadwinner than when you're a retiree with grown children and a
nice nest egg.
Whole life insurance, meanwhile, is
designed to cover you for your whole life. These policies charge you a fixed
premium each year, one that's typically higher than term insurance. The
advantage touted by insurance companies for whole life insurance is that,
while part of the premium covers what term insurance would cost, the surplus
resides in an account that pays interest and accumulates a cash value. As
this "accumulation account" grows, your premiums can decrease over time.
Eventually, in some cases, the interest earned can pay the premiums for you.
So, you won't be paying any more premiums, but you'll still be covered for
the rest of your life.
The problem with whole life insurance
is that insurance companies tend to offer low interest rates to
policyholders, while they typically earn much greater returns because they
invest the money in stocks and bonds. Policyholders are indeed earning a bit
of money through the policy, but as an "investment," it leaves a lot to be
desired.
Enter "universal" life insurance, a
form of whole life insurance. With universal life, in years when the
insurance company earns more on policyholders' accumulation accounts than
they promised, they pass along the extra gain. This sounds good but, in some
situations, due to overly optimistic assumptions by insurers about returns
customers will earn, customers can end up paying more than they expected.
"Variable" life insurance policies, which invest in sub-accounts that look
like (but legally are not and cannot be) mutual funds, carry the same
danger.
With universal and variable insurance,
the higher the initial assumed rate of return, the lower the annual payments
will be. This is how some unscrupulous agents can sign you up -- through
very attractive policies based on unreasonable assumptions. Since most
insurers invest to a great degree in bonds, be skeptical of any promised
universal rates much higher than the 30-year Treasury rate. With variable
insurance, since most mutual funds have trouble beating the S&P 500's
average historical return of 10-12% per year, we'd be skeptical of any
projected rates in that neighborhood. |