Personal Finance Tips

The distinction made by the insurance industry is between term and permanent life insurance. So you either buy a policy for a fixed term of years which then expires, or the policy is “permanent”, i.e. it usually stays valid and enforceable during your life. The other elements of permanence cover the premium rate which can remain the same throughout your life and the terms of the policy which continue to apply regardless of any change in your health or other circumstances. Never liking to leave anything really simple and straightforward, the industry then divides policies into three basic types. The first is the so-called whole life policy which many consider the most appropriate because the insurers tend to offer minimum guarantees. Why are guarantees useful? For someone aged in their twenties, it is difficult to predict what will happen over the next fifty years (allowing for the average life expectancy). Despite the fact that stock markets have shown steady growth over time, this is partly due to inflation. The buying power of the dollar today will be worn away by price increases, so the numbers representing stock values have to keep rising to keep pace. This is not an increase in real values. It simply prevents a loss of value. So, if an insurer today guarantees you a minimum rate of return over your lifetime, and that rate is better than inflation, it looks a good deal to take it. Better the known than the unknown.

The second type of policy is the universal which offers more flexibility, allowing you to vary the amount you pay into the fund according to changes in your financial circumstances. When you are new to the world of employment, pay is low and so you start with a low premium rate. As your pay increases, you increase the premium rate. If there is a family emergency, you can elect not to pay for a period of time. The key difference is that a whole life policy collects and adds dividends to the cash value, whereas the universal simply pays interest on the cash in hand. Despite this, there are minimum values guaranteed but they tend to be lower than the guaranteed amounts in whole life policies. The third type of policy, the variable, appeals to those with a higher risk appetite. It gives you more control over the investments. Some insurers do offer you guidance on investment strategies, but the price of your management is you take responsibility for generating the returns. The insurer does not give anything more than a token guaranteed minimum for the benefits payable to your dependents.

As suggested in previous articles, the promise of growth in cash value, whether through investment or the payment of interest, is something of a smokescreen. When you are going through the life insurance quotes to decide which policy might represent the best buy for you, do not focus on the investment opportunities. Analyze the life investment quotes to find the policies offering permanence on the best terms. What you should consider is the possibility of problems with your employment. Is there a way you can keep the policy in place if you cannot afford to pay the same level of premium? Some allow you to convert the policy to one fully-paid-up, using the cash value to buy future years. Others allow you to suspend payment for a period. Since your main purpose should be protecting the interests of your dependents, keeping the policy in place is the most important factor.

The biggest financial decision you are likely to make is buying a home, closely followed by less expensive must-haves like a vehicle. But the one deal you should aim to get right is the decision on life insurance. This is the difference between leaving your dependents with an adequate amount of cash to see them through the times of economic hardship after your income is lost, and leaving them with nothing. In this, the decision on term as against permanent insurance is the key. Put the wrong key in the lock and you open a door into real financial hardship. So what’s wrong with term insurance? Think of this as like a bet. If you die within the term, your dependents are the winners. If you prove healthy and live too long, you lose the premiums you paid and your dependents get nothing. Now, when it comes to permanent insurance, this builds up a cash value. The longer you have the policy in place, the more valuable it comes as the premiums you pay attract investment returns. During your own life, you can take some of this money back or borrow using the fund as collateral. When the sad day finally comes, the benefits are paid out to your dependents less whatever drawings or borrowings you have made.

From these short sentences, you will immediately suspect the other difference between the products. Term life insurance is the cheap option. It gives you security in the amount of the benefits for the number of years you select. If you buy one term policy after another, the premiums are higher each time because your life expectancy is less on each renewal. Permanent insurance premiums are higher because a percentage of what you pay is invested on your behalf to generate the cash value. So your fund receives the benefit of the interest, dividends and other returns the investments generate. This makes the total of the cash value the key factor. Do you want a higher rate of return on the premiums? This can be for your own benefit should there be an emergency during your life. Or it can build up over the years for your dependents. If the answer is yes, you must be prepared to pay more to start off the policy – the first year’s premiums often disappear into a black hole representing set-up costs and the selling agent’s commission. But the amount you pay stays the same throughout the lifetime of the policy. So, with inflation, what starts out a struggle slowly grows easier to pay.

The real problem is the uncertainty of the future. Who knows how inflation may affect different aspects of life. What may be cheap now, may be expensive tomorrow and vice versa. So here are a few simple rules. If all you want is cover over the next few years (no more than ten), get life insurance quotes for a term policy. Ten years is not a long enough period of time to build up a worthwhile cash value. Estimate what benefits might be needed, e.g. your daughter will need $50,000 to cover her college tuition fees, and the total will set the amount of the insurance. If you are looking at a period of at least twenty years, you should think seriously about permanent insurance. Again, get life insurance quotes but you should also take advice on the different types of policy available and create or review your estate plan. Between ten and twenty years is a gray area and whichever way you decide is not going to be wrong.