Life Insurance Part 4 – What Kind Should You Buy?

One of the more confusing aspects of picking the right life insurance is deciding which kind of policy best fits your needs. It seems there are endless variations and names to choose from—universal life, variable life, Irreplaceable Life, The Champion, The Solution. It’s important to know that all are actually variations on the two basic kinds of coverage: term insurance and whole-life insurance (also called cash value or permanent).

Reasons for Term Insurance
The fundamental purpose of life insurance is to provide dependents with the financial support they would lose if you died. If it is a financial struggle for you to buy enough insurance to accomplish that goal, then term is what you should buy. Dollar for dollar, term gives you the most protection for your money. Period.

Beyond that important truth, the same arguments for term are the arguments against whole life. While it is true that the cash value in a whole-life policy could add to your financial resources over the years, you can’t actually get your hands on the cash unless you surrender the policy (which terminates your coverage) or borrow some of it. Borrowing against the policy keeps your policy active, but any unpaid loan balance will be deducted from the face amount if you die. To restore the full face amount of the policy, you’ll have to repay the loan, plus interest.

Just how expensive are loans against your life insurance? Some companies charge interest rates that vary with the current market. Others use a method called “direct recognition” which reduces dividends to reflect the amount of the cash value encumbered by your loan. Under direct recognition, in effect, the more you borrow the less your policy earns. Either approach can make these loans more expensive than they appear. You could choose to leave your options open by starting with a term policy that allows you to convert to whole-life coverage any time in the life of the policy.

Reasons for Whole-Life Insurance
One of the strongest arguments for the whole life policy is that the cash value builds up tax free, which significantly increases the compounding power of your earnings. If you have maxed out on 401(k) plans, IRAs, and other tax- sheltered savings and investment plans, then cash- value insurance provides another option. It’s very possible that a $250,000 policy bought at age 35 could accumulate a cash surrender value of $100,000 by the time you reach age 65. If you don’t need the insurance anymore, the money could be a nice supplement to your retirement nest egg.

Additionally, you can turn in your policy any time after the first several years and collect the cash value, with no questions asked. And the proceeds are tax free to the extent that the cash value doesn’t exceed the premiums you’ve paid. Or you can borrow against the cash value and leave the policy in force, with no requirement that you pay the money back although you will owe interest on the loan. Also, don’t forget that if you die with a loan still outstanding, it will be deducted from the face amount paid to your beneficiaries.

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