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What's the difference between term life
and whole life insurance?
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What types of term policies are available?
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What are universal and variable life
insurance?
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Do you recommend term life or whole life insurance?
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How is the premium determined on a term policy?
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What's the difference between term life
and whole life insurance?
These are the two main forms of life insurance you need to
understand. With term insurance, you're covered only during the life
of the policy, while you're paying the premiums. If you carry a term
life insurance policy for 25 years, regularly pay the premiums, and
then quit paying and die a year later, your beneficiaries will be out
of luck. Term insurance is cheaper than cash value or whole
life insurance, because the owner of the policy only pays for death
protection. No cash value is built up. Term insurance becomes more
expensive as the policy holder grows older, because he or she is
statistically more likely to die.
Cash value or whole life insurance, meanwhile, is
designed to cover you for your whole life. These policies charge you
a fixed premium each year, one that's typically higher than term
insurance. The advantage touted by insurance companies for whole life
insurance is that, while part of the premium covers what term
insurance would cost, the surplus resides in an account that pays
interest and accumulates a cash value. As this account grows, your
premiums can decrease over time. Eventually, in some cases, the
interest earned can pay the premiums for you. So, you won't be paying
any more premiums, but you'll still be covered for the rest of your
life. Often, the insured can borrow against the cash value in
the policy at better than market rates.
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What types of
term policies are available?
There are several forms of term insurance:
- Level term - This is where you pay a fixed premium
for up to 20 years. This can be a good deal, as it protects you
against the effects of inflation and unexpected changes in your
health that would warrant higher premiums.
- Annual renewable term - This gives you the option of
renewing your policy regularly, but at increasing premium
rates.
- Decreasing term - These policies feature a steadily
decreasing death benefit. This might seem undesirable, but it
can be sensible for many people. You may need a bigger benefit
when you're a young bread winner for your family than when
you're a retiree with grown children and a nice nest egg.
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What are universal and variable life
insurance?
Universal and variable life insurance are a form of whole life
insurance. The problem with whole life insurance is that insurance
companies tend to offer low interest rates to policy holders, while
they typically earn much greater returns because they invest the
money in stocks and bonds. With universal life, in years when the
insurance company earns more on policy holders' accumulation accounts
than they promised, they pass along the extra gain. This sounds good
but, in some situations, due to overly optimistic assumptions
insurers make about returns customers will ear, customers can ed up
paying more than they expected to. Variable life insurance policies,
which invest in sub-accounts that look like (but legally are not and
cannot be) mutual funds, carry the same predicament.
With universal and variable insurance, the higher the initial assumed
rate of return, the lower the annual payments will be. This is how
some unscrupulous agents can sign you up--through very attractive
policies based on unreasonable assumptions. Since most insurers
invest to a great degree in bonds, be skeptical of any promised
universal rates much higher than the 30-year Treasury rate. With
variable insurance, since most mutual funds have trouble beating the
S&P 500's average historical return of 10 to 12% per year.
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Do you recommend term life or whole life insurance?
For most people, it probably makes the most sense to stick to term
insurance. Buy just as much insurance as you need, and only for as
long as you need it. With term insurance, you won't be paying
anything extra as an "investment." Instead, put the money you save on
premiums into better long-term investments--such as index funds on
stocks or whatever you're comfortable with. Your own investments are
likely to outperform any investment an insurance company makes for
you. Buy combining term insurance with investments on your own,
you'll be minimizing your insurance costs and maximizing your
investment potential. Also, term insurance is a very competitive
segment of the insurance business, with companies lowering costs to
win customers.
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How is the
premium determined on a term policy?
It's determined by your age at the time of purchase. The older you
get, the more the policy cost.
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