Life insurance, in general, is not a subject many people want to talk about.
After all, its more about death than it is about life. But it is a necessary part of financial planning and a form of insurance many people should have! The two main forms of life insurance are Term Life Insurance and Whole Life Insurance.
Let’s take a look at term life insurance versus whole life insurance:
Term Life Insurance
Term life insurance provides death-benefit coverage for a limited period of time, the relevant term as specified in the term insurance policy (this could be 1, 5, 10, 20, or 30 years generally).
The death benefit is paid out by the life insurance company only when a claim is filed if the insured dies during the term of the policy. The contract would simply expire if no death occurs by the end of the term.
A term life insurance policy functions much like any other typical insurance (an event triggers payout).
Whole Life Insurance
Whole life insurance guarantees a benefit coverage for the life time of the insured (hence whole life) in the form of either an eventual death benefit or a so-called cash surrender value when the policy holder decides to cash out and effectively cancels the policy.
Term Life Insurance as a Pure Death/Risk Protection
Because a term life insurance policy only pays the claim upon the insured’s death within the stated term, a term life policy is for pure protection, as opposed to having certain savings elements in a whole life insurance policy.
Term life insurance is mostly used to provide coverage of the insured’s financial responsibilities for the family, such as mortgage payments, consumer debt, child raising, college education, etc., in the event of the bread earner’s death.
Term life insurance is also the most inexpensive way to obtain a substantial death coverage on a per premium dollar basis, as term insurance companies can easily collect enough premiums against few claims. It is the low likelihood of insurance companies having to pay a death benefit that makes term insurance premiums low and affordable (since term life expires, many policies expire before a claim is made).
Whole Life Insurance as a Savings Instrument
All life insurance was originally term insurance.
But because term life insurance does not pay out anything absent of a death claim and policy holders can pay premiums for 20 or 30 years and get nothing when the term expires, whole life insurance was later devised in response to the kind of upset from certain term insurance customers.
However, to guarantee a death benefit for every whole life insurance, premium payments have to be much higher than those on traditional term insurance to allow a cash reserve to build up against the known, rather than the uncertain, eventual death claims. In a sense, a whole life insurance policy is transformed into a life savings mechanism, as policy holders essentially make savings contributions themselves to pay for their eventual death benefit to their beneficiaries. And as such, their account does accumulate interest over time into a cash value. But the total premiums paid can be as high as 10 times comparing to a term life insurance.
Savings in the form of overpaid premiums can be returned in a later withdrawal, should the policy holder wish to cash out the insurance policy and forgo the eventual death benefit. The non-savings part of the premiums, roughly the amount as if it were for a term life, is retained by the insurance company on the ground that the company has effectively provided a risk protection up to the point of the cash surrendering.
Whole life insurance has over time lost its popularity mostly because it’s too expensive. In fact, many financial advisers suggest a separation of life insurance from savings–buy the inexpensive term life insurance and invest the saved premiums elsewhere. Still, a whole life insurance can have its place, such as guaranteeing insurance if you believe you my have trouble getting a term plan later on in life.
Life insurance isn’t a topic most people want to discuss. But it’s an important instrument that can help protect a family as well as possible provide an investment as well.
In order protect your family you need to understand the different kinds of life insurance. There are many out there that swear by one type of insurance or another. Do your own research and find life insurance that best fits you and your family.
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