Have questions about life insurance or income protection (disability insurance)? Principal can help.
Q. Does it make sense to buy both term life insurance and permanent life insurance?
A. While many people debate about whether to purchase term or permanent insurance, it may be a wise strategy to purchase both.
Why? It can be expensive (and often financially impossible) to satisfy a person’s entire insurance need with permanent insurance. Buying some term insurance makes it possible to meet the total insurance need now, and it can often be converted to permanent insurance with the same company at a future date—without going through underwriting at the time of conversion.
The combination strategy also makes sense for young families, especially if additional children are planned. By supplementing the purchase of a permanent policy with term insurance, families can assure their future insurability.
Buying convertible term insurance during healthy, younger years helps avoid the question of insurability in later years, and with term insurance priced most efficiently at young ages, it’s a sound financial decision too.
Q. What factors impact the cash value of my policy?
A. Insurance policy cash values are impacted by the insurance company investments that back your policy, as well as mortality and expenses.
Universal Life Insurance policies are fixed-interest rate policies. In exchange for a guaranteed interest rate, the insurance company reserves the right to invest policy premiums in conservative fixed-interest investments such as bonds. In addition to the guaranteed interest rate, Universal Life policies also have a current interest rate that may be higher than the guaranteed rate.
Variable Universal Life Insurance, on the other hand, may be an answer for policy owners who can tolerate more risk and seek control over the allocation of their premium dollars. In exchange for the opportunity for higher returns, the policy owner reserves the right to allocate premiums to a variety of investment choices with varying levels of risk.
The range of alternatives includes small, medium, and large company stocks, passive and active management styles, and domestic and global investment approaches. Other common investment divisions inside of Variable Universal Life products include fixed-income investments, such as bonds and even guaranteed interest accounts.
Q. Can I use my cash value?
A. The cash value that accumulates inside a permanent life insurance policy can be accessed in three ways.
Loans are typically free from current income tax, even if they exceed the premiums paid or cost basis in the policy. Outstanding loans are deducted from the death benefit upon the death of the insured, or if the policy is later surrendered, the unpaid loan amount is deducted from the cash value. Interest is charged on the loan and may either be paid or accrued to the loan. Look for a policy that helps minimize costs with a contractually reducing net loan rate after a given number of years.
Partial surrenders from Universal Life policies reduce the death benefit, dollar for dollar. They are usually income tax-free, unless they exceed the premiums paid or cost basis. This is one of the potential benefits of life insurance, yet not many people are aware of it.
Full surrender means taking the entire remaining cash value from a policy and ending the policy. It will trigger an income tax obligation for any portion of the cash value that exceeds premiums paid. The unpaid balances of any loans will be forgiven at the time of surrender, but will be added to the surrender value when calculating the tax on the proceeds.
Withdrawals (or loans) from policies called “modified endowment contracts” can incur taxes and early withdrawal penalties. Be sure to consult with your financial representative and your tax advisor about the tax benefits and liabilities of any insurance policy.
Q. How is the death benefit paid?
A. Death benefit settlement options may be selected either by the owner (prior to death) or the beneficiary (after death). Options typically include:
- Lump sum, where the death benefit is distributed to the beneficiary in one payment
- Income options, where the death benefit is kept by the insurance company and an income is paid to the beneficiary for life (or for some other stated period of time)
- A continued interest account, where the death benefit is held by the insurance company in an interest-bearing account, which can be accessed by the beneficiary upon demand
Q. What is underwriting all about?
A. Underwriting enables insurance companies to charge rates commensurate with the risk of insuring specific individuals. As part of this process, you may be asked questions or required to undergo medical tests or exams. Underwriting time can vary from a few days to a few weeks, depending on the complexity of the case and the time it takes to get information from third parties, such as your doctor.
Q. How are the costs of life insurance calculated?
A. The cost of a life insurance policy is generally based on three factors: mortality, expenses, and riders. Mortality is the calculated likelihood that the insured will die, largely based on age, gender, health, occupation, and hobbies. Expenses include the cost of operating the issuing company and administering the policy. Riders added to the base policy may require additional premiums.