A generation ago, from the 1940s to about 1970, people tended to purchase whole life insurance. Also referred to as “permanent insurance,” these policies secured the breadwinner’s income for their family in case of an untimely death. Business succession planning and estate planning also utilized permanent life insurance to ensure a partner’s share could be bought after his or her death and to facilitate heirs’ payment of the estate taxes due at the death of an owner of a large estate. In addition to providing lifelong coverage to protect one’s dependents, permanent life insurance includes an investment component. The policy’s “cash value” grows tax-deferred and possibly tax free. In other words, you don’t pay taxes on the policy’s growth as the cash value increases in value.
Another sometimes overlooked option is term insurance where the insured chooses sufficient coverage that is needed for a certain period of time. Like permanent insurance, term insurance coverage protects one’s dependents in case of a premature death. If you have a term policy and die while the policy is in force, your beneficiaries receive just the death benefit. There is no cash value to term policies.
Term insurance wasn’t very prevalent until the early 1980s. Perhaps the catalyst driving term’s popularly was the passage of the Tax Equity and Fiscal Responsibility Act (TEFRA) in 1981, after which many insurance companies and banks became very interest rate sensitive. Moreover, investors began to lose interest in permanent life insurance products when they could pursue potentially greater returns in the increasingly broad array of stocks, bonds and mutual funds. With the bulk of their assets invested in the market, investors began to favor the less expensive term life insurance for protection.
In my view, especially for young couples with limited assets and cash flow challenges, the easiest way to get adequate life insurance is to buy term insurance that provides coverage for a certain time period. You can choose a term of one year to 30 years with many companies and, with most policies, the premium stays the same throughout the entire term. The term you choose should coincide with the years you think your family would be most financially vulnerable. For instance, some families insure themselves long enough to see their youngest child through college. It’s also important to select a benefit amount that’s high enough to both replace your income and help your family pay for services you perform, such as child care. At some point, the need for insurance may go away or may be substantially reduced once the children are through college and once sufficient assets have been accumulated, i.e., the insured may now be self-insured.
Young couples often make the mistake of choosing a permanent life insurance policy that doesn’t provide a large enough death benefit because it was all they could afford. In those cases, term life insurance may have been a better choice. Of course, if your needs change and one day you might want whole life insurance, most term life policies are convertible to permanent coverage. Of course, rules and costs for conversion vary by policy and life insurance company.
If you are uncertain whether you have the right type and/or amount of life insurance, contact your trusted fee-only financial advisor to discuss your life insurance needs. Your fee-only advisor can refer you to the appropriate life insurance professional.