Protecting your family with insurance is a must – but which type to choose?
Written by Joseph Regan on June 07, 2018.
With family comes responsibility and that includes financial responsibility. Although financial planning is best started as soon as you begin your career, in reality becoming a parent is often the catalyst for many people to start taking their financial planning seriously. One really important element of financial planning from a peace of mind point of view is life insurance to protect your family in the event of your death.
There are two main types of life insurance policy: term life and whole life. Both perform the same function, which is to provide an injection of cash for your family to live off in the event of your untimely death. However, the two types differ significantly both in terms of costs and benefits.
I thought it would be useful to summarize the two to help you make up your mind how best to protect your family.
Term life insurance
Term life insurance is the less expensive option and is purchased for a specified period – usually 10, 20 or 30 years. The idea is that the need is temporary and often the term will be linked to specific outgoings during this period.
Let’s say you are in your early 30s with young children and have recently taken out a 20 year mortgage on your home. You might take out a 20 year term life insurance policy to cover the payment of the mortgage, schooling and living costs for your family. By the time the 20 years have passed your mortgage will be paid off and your children – theoretically! – will be supporting themselves so the insurance is no longer required.
Term life insurance policies do not accumulate a cash value. If you die, the death benefit, or face value, which is linked to the premium that you pay, is paid out to the beneficiaries that you have named on the policy.
Once the initial term runs out, the policy terminates unless you renew for another term, which will often be expensive (because you are older and, to put it bluntly, the odds of you dying are higher).
There are a few variations of term life policies including decreasing term insurance where the benefit is reduced each year although premiums remain the same. This can bring down the cost and is often used to protect against your heirs having to repay a large debt such as a mortgage. As the mortgage balance reduces year on year, the amount of insurance required also declines.
Whole life insurance
As the name suggests, this kind of policy offers lifelong protection and as a result will cost you more. This is because the premiums you pay have to compensate for the higher mortality risk as you get older but also because this kind of policy accumulates a cash value over time and works a bit like a savings account, often with a facility to borrow against the whole life policy if necessary. For this reason, they are a useful tool in retirement planning - but be sure to choose an insurance company with a proven track record of financial stability to safeguard your savings.
Whole life policies address a permanent insurance need, for example, you would like to leave your heirs $200,000 when you pass away. Traditional ordinary life or straight life policies are the most common kind of whole life insurance. These fix a premium and a guaranteed cash value upon death or until the policyholder reaches the age of 100. You might use this kind of policy to supplement a spouse’s income if you were to pass away:
• To cover funeral expenses
• As estate planning tool, to pay capital gains tax OR inheritance tax payable on your death
• To leave a legacy which falls outside of your estate
There are a number of other different varieties of whole life insurance, including:
• Single pay – one lump sum is paid when the policy is taken out with no further premiums.
• Limited pay – premiums are paid for a specified period and will usually be higher as you are only paying, for example, for a 20 year period or until you reach 65.
• Graded premium – premiums increase over time
• Adjustable life – death benefit and/or premiums can be modified over time
The kind of insurance that you need will ultimately depend on your personal situation and the financial goals that you set. If you are unsure you should talk through your requirements with your financial adviser. If you don’t have a financial adviser, I’d be happy to help and you can contact me for a free, no-obligation consultation by emailing me at email@example.com.