
People have two options when it comes to purchasing life insurance: term or permanent. Financial advisors suggest that term life is typically the most budget-friendly option; however, it only made up 40% of policies sold in 2021, compared to the 60% of permanent policies sold, as reported by the American Council of Life Insurers. Whole life and universal life are both categorized as permanent policies.
Many households are not opting for the most economical option when it comes to life insurance, as there are two distinct types. According to the most recent data from the American Council of Life Insurers, 4.1 million term insurance policies were purchased in 2021, making up 40% of all individual policies that year, while 6.3 million policies, or 60%, were permanent life insurance. This is an interesting statistic given what financial advisors typically suggest. Carolyn McClanahan, a certified financial planner and member of CNBC's Advisor Council, noted, "Most people just need term insurance."
Life insurance provides financial security for loved ones by paying out a death benefit if the policyholder passes away. Term insurance offers coverage for a specific period, but unless renewed, the policy lapses after the specified term. Permanent insurance policies, including whole life and universal life, provide continuous coverage until the policyholder dies and are also referred to as cash value policies because they include interest-bearing accounts.
Advisors indicated that permanent insurance tends to be more expensive. With these policies, premiums are paid over a longer period and these payments are utilized to both cover insurance costs and accumulate cash value. Marguerita Cheng, a CFP based in Gaithersburg, Maryland and a member of CNBC's Advisor Council, stated that term insurance is typically the most economical way to provide survivor income, especially for minors. Premiums can greatly differ depending on an individual, as insurers base them on the policy's face value, the policyholder's age, gender, health, family medical history, lifestyle, occupation, and other elements.
McClanahan, founder of Life Planning Partners, outlines three reasons why a permanent policy may be more beneficial than a policy with higher premiums. In the event of the policyholder's death, there would be an insurance payout, no matter when it occurs. This could be beneficial for children with special needs who may require long-term financial help, or to leave a legacy for family and charities. Additionally, if a health condition worsens, the policyholder may become uninsurable and having the policy today would secure coverage for the future.
Shoppers should not buy a permanent life insurance policy in the hopes of accessing its cash value, according to McClanahan. Primarily, life insurance is purchased for an insurance need, and taxes or penalties may be incurred when accessing the cash value. Additionally, withdrawing too much money could cause the policy to lapse, resulting in the loss of the insurance. Policyholders should use the cash value as an emergency fund at the end of their life, like home equity.
When deciding the amount of life insurance to purchase, Cheng, CEO of Blue Ocean Global Wealth, encourages prospective buyers to take into account the three Ls: liability, loved ones, and legacy. For instance, what amount of money would be needed to cover liabilities such as a mortgage, student loans or auto loans in the event of a policyholder's death? Additionally, how much money would family members, including a spouse and children, need to maintain their lifestyle if they suddenly lost the policyholder's income? Finally, what amount of money would you like to leave behind as a legacy for causes that are meaningful to you? Considering these questions can help determine which term of policy to buy, Cheng says, providing her own story as an example. She purchased a 20-year term policy with a $750,000 death benefit when her three kids were under 18, as well as a $250,000 permanent policy to help pay off her mortgage. Combining a term and permanent policy can help make life insurance more cost-effective than buying only a permanent policy, advisors explain. It is advised also to buy convertible term insurance, which allows the policyholder to transform their term policy into a permanent policy without submitting to another medical exam. This can be beneficial as a person can be denied coverage if their health is poor.
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