Different Types of Insurance

Term or Cash Value Policies

A phrase you may have heard when considering insurance is to "buy term and invest the difference." (You likely don't hear this from insurance agents because they are paid a higher commission on cash-value policies.) To implement this strategy, buy low-premium term insurance from a highly-rated insurer, and put the money saved from not buying a cash-value policy into a true investment account like an IRA, Roth IRA, etc... This provides your family with the protection it needs and an efficient way to save for retirement. Hopefully, over time, the investment account will grow and the need for an insurance policy will be eliminated.

I, like most fee-only financial planners, am a proponent of the "buy term and invest the difference" strategy. However, there are certain occasions when a cash value policy may make sense. For instance, buying a cash value policy may be appropriate if your need is permanent, such as caring for a special needs child. Additionally, cash value policies may make sense if your need is certain, such as if you have the policy and are then diagnosed with a terminable disease.

Universal Life

Universal life is a slightly different kind of cash value policy, but at death it works the same way. Before death, however, the cash-value grows at varying rates, depending on the ups and downs of interest paid on bonds and savings accounts. With most cash value accounts (whole life), the interest paid is fixed.

Variable-Universal Life

Variable-universal life policies are very similar to universal life policies, except the cash value can be invested in a pool of stocks or bonds rather than at the insurance company's current interest rates. However, the fees on these policies can be extremely high, and in almost every circumstance the "buy term and invest the difference" strategy is more efficient.

Canceling a Policy

Canceling a term policy is simple - just stop paying the premium, and your heirs will no longer receive a death benefit if you pass away. If you cancel a cash value policy, your refund will be the cash value minus any unpaid loan and interest. It will be further reduced by surrender charges. If you cancel a variable universal life policy, you will also pay ordinary income taxes on the profits inside the policy instead of lower capital gains rates that would be incurred if the investments were separate from insurance. Chances are, your insurance agent forgot to mention these things.

Bottom Line

Insurance is clearly a complicated product. For many, it is a necessity. However, don't speak to a "financial planner" who is an insurance agent because his advice will certainly be to buy life insurance. Speak to a fee-only financial advisor who is never compensated based on the product recommended to get an objective opinion of whether you and your family have adequate coverage.