Imagine this life event: It’s a cool summer evening. Sarah and Mike, a married couple both in their mid-40s, are sitting at the kitchen table reviewing college-fund statements for their two teenagers. Mike’s income covers their mortgage, car payments, and the family’s comfortable lifestyle. Then, without warning, Mike suffers heart failure and passes away.
Over the course of the weeks that follow, the grief is overwhelming, but financial panic is never experienced. Because Mike had purchased a 20-year term life insurance policy a few years ago, Sarah receives a tax-free death benefit that is substantial enough to pay off the mortgage, cover college tuition for both of their children, and replace Mike’s income for a period of time until she is able to make a career adjustment. The family’s financial future remains stable.
This is the core purpose of life insurance – to replace the financial value of a life that is suddenly lost. It’s not an investment or a retirement account, but a promise that people you love will not experience financial hardship because you are no longer here to provide for them.
When Term Life Serves the Purpose
For many families, the need for life insurance is temporary. Protection is needed while you still have a mortgage, young children, or any dependents that rely on your income. Once those responsibilities end—the children graduate, the mortgage is paid off, and retirement savings have accumulated—the initial purpose for a large death benefit generally fades.
Term life insurance offers pure protection at a price that is more broadly affordable. Unlike whole, universal and variable life policies, it does not offer or accrue any cash-value. The premium goes toward the death benefit and keeps the cost lower. Term insurance does offer the option to extend coverage or convert it to another policy type later. At the end of the term, you can let the policy expire if you are no longer in need of the coverage.
Term life does precisely what insurance is supposed to do, by assuming the risk of financial vulnerability for a period of time at an affordable rate.
Permanent Life Insurance Polices
Whole, universal and variable life insurance policies combine a death benefit with a savings component that generates cash value over time. Optional insurance riders can be added to a standard policy to broaden coverage, address a specific need such as long-term care, or protect valuable items. Most riders will increase the policy premium.
In addition to cash-value, a few key benefits of permanent policies include coverage after retirement to address a lifelong need (e.g., special-needs family member) or the utilization of the policy as an estate planning tool that provides a tax-free benefit to heirs or beneficiaries. A permanent policy can offer greater peace of mind for older policyholders or if health concerns arise.
In theory, you can borrow against the cash value or even use it to cover future premiums. In practice, these types of permanent policies come with significantly higher premiums, which are utilized to fund the insurer’s own profit margins and investment strategies responsible for crediting interest to a policy’s cash-value component.
Some factors may diminish the need for “cash-value” policies or result in the policyholder discontinuing payment of the premiums, such as:
- Life Changes: When the kids are grown, the mortgage is paid, and the surviving spouse no longer needs a large death benefit, maintaining an expensive permanent policy may not make sense.
- Opportunity Costs: Other investment opportunities or financial priorities may take precedent over funding a permanent policy.
- Underperformance or Increased Fees: Variable and indexed policies are subject to market volatility, and universal life policies can be subject to premium increases when interest rates decline.
It’s important to note that discontinuing payment of premiums on a cash-value policy can cause it to lapse, trigger taxes on any gains above the premiums paid and leave a family without coverage when they may still need it. Before purchasing a permanent policy, it should be known that surrendering (canceling) a policy can result in surrender fees that vary depending on how long you’ve held the policy.
The Bottom Line
Life insurance is not something you just buy and forget about. Markets, your family, your life, and your needs change and evolve over time. A policy that made perfect sense in your mid-30’s may be an expensive drag on your finances in your mid-50’s. These circumstances emphasize the importance of talking to your wealth advisor or reaching out to one for clarity on questions such as:
- What policy is right for me?
- Is a term life policy most suitable?
- When might a permanent life insurance policy make sense?
- Do I need a new policy, additional coverage or maybe no coverage at all?
At Biondo Investment Advisors, we welcome the opportunity to discuss these topics with you and your heirs to determine strategies that are most suitable. An advisor will look at your complete financial picture—your income, assets, debts, estate plan and future goals—to determine an approach that is well aligned to you. You are always welcomed to reach out to me or any member of our investment advisory team to learn more.
