Purchasing a life insurance policy to provide a safety net for remaining family members in the event of a wage earner’s untimely death makes good financial sense. Just like purchasing insurance for home and auto, life insurance provides peace of mind in the event of a tragedy. However, unlike home and auto insurance, the consumer not only has to decide how much life coverage to purchase, but what type of life insurance? And what exactly are the differences in universal life insurance vs. term life insurance?
Understanding Term Life Insurance (Temporary Life Insurance)
Term life insurance is the more popular of the two and is purchased for a specific period of time—typically at 10, 20 or 30-year increments. Some people choose annual increments called an annual renewable term, which usually comes with a premium increase each year. Term life is a simple and affordable option that works best for those with specific short term goals. The younger the person is who purchases the policy, the less expensive it will be and the monthly premium will never increase during its term. However, if even one monthly payment is missed, the policy will terminate.
Term life works especially well for a single or married parent who wants money available for their children in the event they pass on while they are of school age. Depending on the parent’s age when purchasing the policy, the parent can select a time period that would last until their children are of adult age, graduate from college or when their mortgage is paid off, for example. A married couple with no children could purchase a term life policy that would extend until each other’s retirement benefits kick in. This insurance is best when a specific goal is in mind and the purchaser can take advantage of buying the policy when they are younger and in good health. If they wish to continue the policy after the term has ended, they would need to renew the policy for another time period but it would be at a higher price and the application could possibly be rejected if the purchaser was in poor health.
Understanding Universal Life Insurance (Permanent Life Insurance)
A form of permanent life insurance, known as universal life insurance, differs from term life in that it offers an investment component. Premiums are higher than those of term life but the policy is intended to be permanent and provide coverage over a person’s lifetime –up until 100 years old or as much as 120 years old. There is no need for additional medical exams down the road or worry of renewing the policy at a higher rate when older. People who purchase permanent life insurance usually do so because of the investment and savings components they can build into it.
While a typical universal policy may cost thousands of dollars a year at first, the cost goes down as each year passes and at a certain point, there are no premiums and the policy holder can choose to keep the policy intact until their death where the cash value would go to their designated beneficiaries or terminate the policy at some time and receive a cash payout for the current value of the policy. As the tax-deferred funds add up, the policy owner can borrow against the funds, cash some out or use the accumulated funds to pay monthly premiums.
In summary, the biggest advantage to purchasing a term life insurance policy is that it is simple to understand and has low monthly premiums as compared to a universal policy. It covers a specific time period to meet certain short-term financial coverage goals. The downside is there is a definite end date and should the policy owner decide to extend the time, he or she will have to reapply at a higher premium rate and pass a current medical exam. In contrast, the advantage to a universal policy is that the person is covered for their lifetime and while the monthly premiums are higher than term life, a portion of the premium are being invested for them and are available in the future to cash out or borrow against. When the person eventually passes on, both the cash value of the policy and the life insurance payout will be given to their beneficiaries. The downside is the premiums are more costly and the policy does not offer a lot of flexibility should the policy owner want to increase or decrease the amount in the future. Also, the rate of interest earned on the policy may be less than other investment options the person could find on their own.
After making a decision on what type of life insurance to purchase, the purchaser will need to decide on the amount of coverage. When doing their comparison of life insurance companies, the purchaser can work with each company’s representative to determine the best amount of coverage needed based on their financial goals and the type of policy they selected.